Internal Revenue Bulletin 2001-7 (PDF rendition): IRS Announcements

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

# Internal Revenue bulletin

Bulletin No. 2001-7
February 12, 2001

## HIGHLIGHTS OF THIS ISSUE

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

## INCOME TAX

Rev. Rul. 2001-7, page 541.
Federal rates; adjusted federal rates; adjusted fed-
eral long-term rate, and the long-term exempt rate.
For purposes of sections 382, 1274, 1288, and other
sections of the Code, tables set forth the rates for
February 2001.

### T.D. 8917, page 538.

Final regulations under section 467 of the Code provide
amendments to the section 467 regulations, including the
removal of the exception to constant rental accrual for rental
agreements involving payments of $2,000,000 or less.

## EMPLOYEE PLANS

### T.D. 8921, page 532.

Final regulations under section 125 of the Code relate to the
tax treatment of cafeteria plans.

T.D. 8931, page 542.
REG-114082-00, page 629.

Temporary and proposed regulations provide interim guid-
ance on the HIPAA requirements for group health plans not
to establish any rule of eligibility based on a health factor
of any individual and not to charge any individual a greater
premium or contribution based on a health factor than any
similarly situated individual. T.D. 8931 also contains final
regulations for guidance on the HIPAA nondiscrimination
requirements. Public comments on the proposed regula-
tions are requested and must be received by April 9, 2001.

REG-114083-00, page 630.

Proposed regulations provide guidance on the limited excep-
tion for certain church plans to the HIPAA nondiscrimination
requirements for group health plans. Public comments are
requested and must be received by April 9, 2001.

REG-114084-00, page 633.

Proposed regulations provide guidance on the exception for
bona fide wellness programs to the HIPAA nondiscrimination
requirements for group health plans. Public comments are
requested and must be received by April 9, 2001.

Notice 2001-15, page 589.

Weighted average interest rate update. The weighted
average interest rate for January 2001 and the resulting per-
missable range of interest rates used to calculate current lia-
bility for purposes of the full funding limitation of section
412(c)(7) of the Code are set forth.

Rev. Proc. 2001-17, page 589.

Administrative programs; closing agreements. This
procedure updates and expands upon the Service's correc-
tion programs for retirement programs within the jurisdiction
of the Commissioner, Tax Exempt and Government Entities
Division. Rev. Proc. 2000-16 modified and superseded.
Rev. Proc. 2001-8 modified.

## EXEMPT ORGANIZATIONS

Announcement 2001-14, page 648.

This announcement requests comments and suggestions from
the public for topics for Exempt Organizations plain-language
publications and voluntary compliance programs.

Finding Lists begin on page ii.
Announcements of Disbarments and Suspensions begin on page 649.

Department of the Treasury
Internal Revenue Service

## The IRS Mission

Provide America's taxpayers top quality service by help-
ing them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness to
all.

### Introduction

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents are consolidated semiannually into
Cumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless oth-
erwise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Ser-
vice personnel in the disposition of other cases. In applying
published rulings and procedures, the effect of subsequent
legislation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same
conclusions in other cases unless the facts and circum-
stances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I .- 1986 Code.

This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.

#### Part II .- Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.

Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Ad-
ministrative Rulings. Bank Secrecy Act Administrative Rul-
ings are issued by the Department of the Treasury's Office
of the Assistant Secretary (Enforcement).

#### Part IV .- Items of General Interest.

This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual
basis, and are published in the first Bulletin of the succeed-
ing semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

## Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

### Section 42 .- Low-Income Housing Credit

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

### Section 125 .- Cafeteria Plans

26 CFR 1.125-4: Permitted election changes.

#### T.D. 8921

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

#### Tax Treatment of Cafeteria Plans

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains
final regulations relating to section 125
cafeteria plans. The final regulations clar-
ify the circumstances under which a cafe-
teria plan may permit an employee to
change his or her cafeteria plan election
with respect to accident or health cover-
age, group-term life insurance coverage,
dependent care assistance and adoption
assistance during the plan year.

DATES: Effective Date: These regula-
tions are effective January 10, 2001.

Applicability Date: See the Scope of
Regulations and Effective Date portion of
this preamble.

FOR FURTHER INFORMATION CON-
TACT: Christine L. Keller or Janet A.
Laufer at (202) 622-6080 (not a toll-free
number).

SUPPLEMENTARY INFORMATION:

### Background

This document contains amendments to
the Income Tax Regulations (26 CFR part
1\) under section 125 of the Internal
Revenue Code (Code). Section 125 gener-
ally provides that an employee in a cafete-
ria plan will not have an amount included
in gross income solely because the
employee may choose among two or more

benefits consisting of cash and qualified
benefits. A qualified benefit generally is
any benefit that is excludable from gross
income under an express provision of the
Code, including coverage under an
employer-provided accident or health plan
under sections 105 and 106, group-term
life insurance under section 79, elective
contributions under a qualified cash or
deferred arrangement within the meaning
of section 401(k), dependent care assis-
tance under section 129, and adoption
assistance under section 137.1 Qualified
benefits can be provided under a cafeteria
plan either through insured arrangements
or arrangements that are not insured.

In 1984 and 1989, proposed regulations
were published relating to cafeteria
plans.2 In general, the 1984 and 1989 pro-
posed regulations require that, for benefits
to be provided on a pre-tax basis under
section 125, an employee may make
changes during a plan year only in certain
circumstances. Specifically, Q&A-8 of
§1.125-1 and Q&A-6(b), (c), and (d) of
§1.125-2 permit participants to make
benefit election changes during a plan
year pursuant to changes in cost or cover-
age, changes in family status, and separa-
tion from service.

In 2000, final regulations3 were issued
permitting a participant in a cafeteria plan
to change his or her accident or health cov-
erage election during a period of coverage
in specific circumstances such as where
special enrollment rights arise under section
9801(f) (added to the Code by the Health
Insurance Portability and Accountability
Act of 1996 (HIPAA)(110 Stat. 1936),
where eligibility for Medicare or Medicaid

1 Section 125(f) provides that the following are not
qualified benefits (even though they are generally
excludable from gross income under an express pro-
vision of the Internal Revenue Code): products
advertised, marketed, or offered as long-term care
insurance; medical savings accounts under section
106(b); qualified scholarships under section 117;
educational assistance programs under section 127;
and fringe benefits under section 132.

2 49 F.R. 19321 (May 7, 1984) and 54 F.R. 9460
(March 7, 1989), respectively.

3 T.D. 8878 at 65 F.R. 15548 (March 23, 2000).
These final regulations were preceded by temporary
regulations issued in 1997. See 62 F.R. 60196
(November 7, 1997) and 62 F.R. 60165 (November
7, 1997).

is gained or lost, or where a court issues a
judgment, decree, or order requiring that an
employee's child or foster child who is a
dependent receive health coverage. In
addition, the final regulations permit an
employee to change his or her accident or
health coverage election or group-term life
insurance election if certain change in sta-
tus rules are satisfied.

On the same day that the final regula-
tions were issued, proposed regulations4
were also issued containing change in sta-
tus rules that apply to other types of qual-
ified benefits (i.e., dependent care assis-
tance and adoption assistance) and
describing the circumstances under which
changes in the cost or coverage of quali-
fied benefits provide a basis for changes
in cafeteria plan elections. The IRS and
Treasury received written comments on
the proposed regulations and held a public
hearing on August 17, 2000. Having con-
sidered the comments and the statements
made at the hearing, the IRS and Treasury
revise the final regulations and adopt the
proposed regulations as modified by this
Treasury decision. The comments and
revisions are discussed below.

### Explanation of Provisions

#### 1. Changes in the March 2000 Final Regulations

With respect to group-term life insur-
ance and disability coverage, the final
regulations issued earlier this year provid-
ed flexibility by stating that, in the event
of a change in an employee's marital sta-
tus or a change in the employment status
of the employee's spouse or dependent, an
employee may elect either to increase
such coverage or to decrease such cover-
age. 5 Commentators recommended that
this rule also apply in the case of birth,
adoption, placement for adoption, or

4 REG-117162-99 (2000-15 I.R.B. 871 at 65 F.R.
15587) (March 23, 2000).

5 For example, an employee might seek to increase
group-term life insurance due to a marriage (because
of the need to provide income to the new spouse in
the event that the chief wage-earner dies) or to
decrease group-term life insurance due to a marriage
(because the new spouse may be a wage-earner who
can support the family in the event that the employ-
ee dies).

death. The argument was made that in
these other situations - because these
types of coverage are generally designed
to provide income, instead of expense
reimbursements - it may be appropriate
for the employee to seek to increase or
decrease the coverage. In accordance
with these recommendations and in the
interest of simplicity, the final regulations
have been modified to allow participants
to increase or decrease these types of cov-
erage for all change of status events.
Further, as also suggested by commenta-
tors, the final regulations have been mod-
ified to expand the rule to apply to cover-
age to which section 105(c) (which is
coverage for permanent loss or loss of use
of a member or function of the body)
applies.

Commentators requested clarification
as to how the election change rules with
respect to special enrollment rights under
section 9801(f) (enacted under HIPAA)
apply to a participant who marries if the
group health plan allows the participant to
change his or her health coverage election
retroactively to the date of the marriage.
In response to this comment, language has
been added to an example in the final reg-
ulations to clarify that an election change
can be funded through salary reduction
under a cafeteria plan only on a prospec-
tive basis, except for the retroactive
enrollment right under section 9801(f)
that applies in the case of an election
made within 30 days of a birth, adoption,
or placement for adoption.

With respect to accident or health cov-
erage, the consistency rule in the final reg-
ulations requires that any employee who
wishes to decrease or cancel coverage
because he or she becomes eligible for
coverage under a spouse's or dependent's
plan due to a marital or employment
change in status can do so only if he or she
actually obtains coverage under that other
plan. Commentators requested clarifica-
tion as to the type of proof an employer
must receive to satisfy this rule, express-
ing concern that a plan could not imple-
ment a change on a timely basis because
of a need to obtain proper proof of the
other coverage. An example in the final
regulations has been revised to make it
clear that employers may generally rely
on an employee's certification that the
employee has or will obtain coverage
under the other plan (assuming that the

employer has no reason to believe that the
employee certification is incorrect ).

The final regulations allow a partici-
pant to change his or her election if a
judgment, decree or order resulting from a
divorce, legal separation, annulment, or
change in legal custody requires that an
employee's spouse, former spouse, or
other individual provide accident or
health coverage for the employee's child
or for a foster child who is a dependent of
the employee. The final regulations were
modified to clarify that the participant can
only change his or her election if the
spouse, former spouse, or other individual
actually provides accident or health cov-
erage for the child.

#### 2. Changes From the March 2000 Proposed Regulations

The final regulations being issued
today are generally consistent with the
proposed regulations that were issued ear-
lier this year, but include various modifi-
cations.

##### Cost and coverage rules

The proposed regulations included
rules allowing election changes in con-
nection with a significant increase in cost
or a significant curtailment in coverage,
irrespective of whether the plan is insured
or not insured. These cost and coverage
rules (and the other rules in paragraph (f)
of §1.125-4) do not apply with respect to
coverage under a health FSA.6 However,
all of the rules in paragraphs (a) through
(e) and paragraph (g) of the final regula-
tions under §1.125-4 do apply with
respect to coverage under a health FSA.
One modification reflected in the final
regulations is to clarify that the cost
increase rules apply when the amount of
an employee's elective contributions
under section 125 increases either due to
the employee contributing a larger portion
of the total cost of the qualified benefits
plan (which might occur, for example, if
part-time employees pay a larger portion
of a plan's cost and the employee switch-

6 A flexible spending arrangement (FSA) is defined
in section 106(c)(2). Under section 106(c)(2), an
FSA is generally a benefit program under which the
maximum reimbursement reasonably available for
coverage is less than 500% of the value of the cov-
erage. A health FSA is an accident or health plan
that is an FSA.

es to part-time status) or due to an
increase in the total cost of the qualified
benefits plan.

In response to comments, modifica-
tions were also made to allow election
changes during a period of coverage when
there is a significant decrease in the cost
of a qualified benefits plan or in the cost
of a benefits package option under the
qualified benefits plan, as well as when
there is a significant increase. Under the
regulations as modified, if there is a sig-
nificant decrease in the cost of a qualified
benefits plan during the plan year, the
final regulations permit a cafeteria plan to
allow all employees, even those who have
not previously participated in the cafeteria
plan, to elect to participate in the qualified
benefits plan through the cafeteria plan.
Similarly, if there is a significant decrease
in the cost of a benefits package option
during the plan year, the final regulations
permit a cafeteria plan to allow all eligible
employees to elect that option (including
employees who have elected another
option, as well as those who have not pre-
viously participated in the cafeteria plan).

Further, in response to comments, mod-
ifications were also made to allow
midyear election changes when there is a
significant improvement in the coverage
provided under a benefit package option,
as well as when there is a new benefit
package option offered under the plan.

Commentators also requested clarifica-
tion as to whether a cafeteria plan could
allow participants to drop coverage in
response to a significant change in the
cost or coverage of a qualified benefit.
The final regulations clarify this issue,
and provide that, if there is no other simi-
lar coverage, employees may drop cover-
age (including a change from family to
single coverage) in response either to an
increase in the cost of a qualified benefit
or to a loss of coverage. The regulations
also permit an employee to elect similar
coverage in response to a significant cur-
tailment in coverage. However, the regu-
lations do not allow an employee to drop
coverage altogether if there is a signifi-
cant curtailment in coverage that does not
constitute a loss of coverage. The regula-
tions list the curtailments that are treated
as a loss of coverage for this purpose, and
include a complete loss of coverage (such
as when an HMO ceases to be available in
an area where an individual resides, or

when an employee or a covered member
of the employee's family loses all cover-
age under a benefit package option by rea-
son of a lifetime or annual limitation). In
addition, the final regulations allow a
cafeteria plan, in its discretion7, to treat
certain other events as a loss of coverage.
These events include a substantial
decrease in medical care providers (such
as a major hospital ceasing to be a mem-
ber of a preferred provider network or a
substantial decease in the physicians par-
ticipating in a preferred provider network
or an HMO), a reduction in the benefits
for a specific type of medical condition or
treatment with respect to which the
employee or the employee's spouse or
dependent is currently in a course of treat-
ment8, or any other similar fundamental
loss of coverage.

For purposes of these rules, a signifi-
cant curtailment occurs only if there is an
overall reduction in coverage provided so
as to constitute reduced coverage general-
ly (i.e., a reduction in the fair market
value of the coverage). Therefore, in most
cases, the loss of one particular physician
in a network does not constitute a signifi-
cant curtailment.

In response to comments, the rule under
the proposed regulations that allowed an
employee to change his or her election in
response to a change made under a
spouse's or dependent's plan has been
clarified and broadened. Under the final
regulations, the rule applies to coverage
available from any employer plan, includ-
ing any plan of the same employer and
any plan of a different employer. In addi-
tion, the regulations have been modified
to allow an employee to elect to partici-
pate in a cafeteria plan if the employee (or
the employee's spouse or dependent)
loses coverage under a group health plan
sponsored by a governmental or educa-
tional institution, such as a state program

under the State Children Health Insurance
Program (SCHIP)9. The regulations do
not allow a cafeteria plan participant to
cease participation in a cafeteria plan if he
or she becomes eligible for SCHIP cover-
age during the year because of a concern
that such a rule would violate a funda-
mental principle of Title XXI of the Social
Security Act that SCHIP coverage not
supplant existing public or private cover-
age.

### Scope of Regulations and Effective Date

These final regulations address all of
the changes in status for which a cafeteria
plan may permit election changes, includ-
ing changes with respect to accident or
health coverage, group-term life insur-
ance, dependent care assistance and adop-
tion assistance. In addition, the regula-
tions contain guidance concerning
election changes that are permitted
because of changes in the cost or coverage
of a qualified benefit plan.

Unless specifically noted, these regula-
tions do not override other cafeteria plan
requirements such as the rules pertaining
to health flexible spending arrangements,
and the rules concerning the Family and
Medical Leave Act (Public Law 103-3
(107 Stat. 6)) 10.

The changes made by these regulations
with respect to the March 2000 final reg-
ulations are applicable for cafeteria plan
years beginning on or after January 1,
2001, except that the clarification made in
paragraph (d)(1)(ii)(B) of these regula-
tions (relating to a spouse, former spouse,
or other individual obtaining accident or
health coverage for an employee's child in
response to a judgment, decree, or order)
is applicable for cafeteria plan years
beginning on or after January 1, 2002.
With respect to the change made in para-
graph (d)(1)(ii)(B) of these regulations,
taxpayers may, until January 1, 2002, rely
on either paragraph (d)(1)(ii)(B) of these
regulations or the final regulations pub-
lished in March 2000 (as
§1.125-4(d)(1)(ii)).

7 Such discretion may be exercised on a case by case
basis, provided that the exercise of discretion satis-
fies section 125(c) which prohibits discrimination in
favor of highly compensated participants.

8 Any reduction in coverage that affects a specific
individual must not violate the prohibition in section
9802 against discrimination on the basis of health
status (and parallel HIPAA provisions in the
Employee Retirement Income Security Act of 1974
and the Public Health Service Act). See §§ 54.9802-
1 and 54.9802-1T(b)(2).

9 Added to the Social Security Act by section 4901
of the Balanced Budget Act of 1997, Public Law
105-33 (August 5, 1997).

10See §1.125-3, published as a proposed rule at 60
F.R. 66229 (December 21, 1995).

The changes made from the March
2000 proposed regulations (including the
rules relating to cost or coverage in para-
graph (f) of these regulations) are applic-
able for cafeteria plan years beginning on
or after January 1, 2002. With respect to
these changes (including the rules relating
to cost or coverage in paragraph (f) of
these regulations), taxpayers may, until
January 1, 2002, rely on either these regu-
lations, the proposed regulations pub-
lished in March 2000 (under §1.125-4),
or the cost or coverage change rules in the
1989 proposed regulations (at § 1.125-2
(Q&A-6(b)).

### Special Analyses

It has been determined that this
Treasury decision is not a significant reg-
ulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions, and because the regulation does not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, these regulations will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its impact
on small business.

### Drafting Information

The principal authors of these regula-
tions are Christine L. Keller and Janet A.
Laufer, Office of Division Counsel/
Associate Chief Counsel (Tax Exempt
and Government Entities). However,
other personnel from the IRS and
Treasury Department participated in their
development.

\*
\*
\*
\*
\*

### Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended
as follows:

### PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Par. 2. 1.125-4 is amended by:

1\. Revising paragraphs (b)(2) Example

2 (ii).

2\. Revising paragraph (c)(1) and adding
paragraph (c)(2)(vi).

3\. Adding a sentence to the end of para-
graph (c)(3)(i).

4\. Removing the last sentence in para-
graph (c)(3)(iii) and adding a sentence
in its place.

5\. Adding paragraph (c)(4) Example 3
(iii).

6\. Revising paragraph (c)(4) Example
4 (ii) and adding paragraph (iii).

7\. Adding paragraph (c)(4) Example 9
and (c)(4) Example 10.

8\. Revising paragraph (d)(1)(ii).

9\. Revising paragraphs (f), (g), (i)(3)and
(i)(4).

10\. Adding a sentence at the end of
paragraph (i)(8), and adding paragraph
(i)(9).

11\. Revising paragraph (j).

The additions and revisions read as fol-
lows:

§1.125-4 Permitted election changes.

* * * * *

(b) * * *

(2) * * *

Example 2. * * *

(ii) M's cafeteria plan may permit E to change E's
salary reduction election to reflect the change to
family coverage under M's accident or health plan
because the marriage would result in special enroll-
ment rights under section 9801(f), pursuant to which
an election of family coverage under M's accident or
health plan would be required to be effective no later
than the first day of the first calendar month begin-
ning after the completed request for enrollment is
received by the plan. Since no retroactive coverage
is required in the event of marriage under section
9801(f), E's salary reduction election may only be
changed on a prospective basis. (E's marriage to F
is also a change in status under paragraph (c) of this
section, as illustrated in Example 1 of paragraph
(c)(4) of this section.)

(c) Changes in status - (1) Change in
status rule. A cafeteria plan may permit
an employee to revoke an election during
a period of coverage with respect to a
qualified benefits plan (defined in para-
graph (i)(8) of this section) to which this
paragraph (c) applies and make a new
election for the remaining portion of the
period (referred to in this section as an
election change) if, under the facts and
circumstances -

(i) A change in status described in para-
graph (c)(2) of this section occurs; and

(ii) The election change satisfies the

consistency rule of paragraph (c)(3) of
this section.

** * * *

(2) * * *

(vi) Adoption assistance. For purposes
of adoption assistance provided through a
cafeteria plan, the commencement or ter-
mination of an adoption proceeding.

(3) Consistency rule - (i) Application
to accident or health coverage and group-
term life insurance. * * * A change in sta-
tus that affects eligibility under an
employer's plan includes a change in sta-
tus that results in an increase or decrease
in the number of an employee's family
members or dependents who may benefit
from coverage under the plan.

* * * * *

(iii) Application of consistency rule. * *
\* With respect to group-term life insur-
ance and disability coverage (as defined
in paragraph (i)(4) of this section), an
election under a cafeteria plan to increase
coverage (or an election to decrease cov-
erage) in response to a change in status
described in paragraph (c)(2) of this sec-
tion is deemed to correspond with that
change in status as required by paragraph
(c)(3)(i) of this section.

(4) * * *

Example 3. * * *

(iii) In addition, under paragraph (f)(4) of this
section, if F makes an election change to cover G
under F's employer's plan, then E may make a cor-
responding change to elect employee-only coverage
under P's cafeteria plan.

Example 4. * * *

(ii) The transfer is a change in status under para-
graph (c)(2)(iii) of this section (relating to a change
in worksite), and, under the consistency rule in para-
graph (c)(3) of this section, the cafeteria plan may
permit A to make an election change to elect the
indemnity option or HMO #2 or to cancel accident
or health coverage.

(iii) The change in work location has no effect on
A's eligibility under R's health FSA, so no change in
A's health FSA is authorized under this paragraph
(c).

** * * *

Example 9. (i) Employee A has one child, B.
Employee A's employer, X, maintains a calendar
year cafeteria plan that allows employees to elect
coverage under a dependent care FSA. Prior to the
beginning of the calendar year, A elects salary reduc-
tion contributions of $4,000 during the year to fund
coverage under the dependent care FSA for up to
$4,000 of reimbursements for the year. During the
year, B reaches the age of 13, and A wants to cancel
coverage under the dependent care FSA.

(ii) When B turns 13, B ceases to satisfy the defi-
nition of qualifying individual under section
21(b)(1) of the Internal Revenue Code. Accordingly,
B's attainment of age 13 is a change in status under
paragraph (c)(2)(iv) of this section that affects A's

employment-related expenses as defined in section
21(b)(2). Therefore, A may make a corresponding
change under X's cafeteria plan to cancel coverage
under the dependent care FSA.

Example 10. (i) Employer Y maintains a calendar
year cafeteria plan under which full-time employees
may elect coverage under either an indemnity option
or an HMO. Employee C elects the employee-only
indemnity option. During the year, C marries D. D
has two children from a previous marriage, and has
family group health coverage in a cafeteria plan
sponsored by D's employer, Z. C wishes to change
from employee-only indemnity coverage to HMO
coverage for the family. D wishes to cease coverage
in Z's group health plan and certifies to Z that D will
have family coverage under C's plan (and Z has no
reason to believe the certification is incorrect).

(ii) The marriage is a change in status under para-
graph (c)(2)(i) of this section. Under the consisten-
cy rule in paragraph (c)(3) of this section, Y's cafete-
ria plan may permit C to change his or her salary
reduction contributions to reflect the change from
employee-only indemnity to HMO family coverage,
and Z may permit D to revoke coverage under Z's
cafeteria plan.

(d) * * * (1) * * *

(ii) Permits the employee to make an
election change to cancel coverage for the
child if:

(A) The order requires the spouse, for-
mer spouse, or other individual to provide
coverage for the child; and

(B) That coverage is, in fact, provided.
** * * *

(f) Significant cost or coverage
changes - (1) In general. Paragraphs
(f)(2) through (5) of this section set forth
rules for election changes as a result of
changes in cost or coverage. This para-
graph (f) does not apply to an election
change with respect to a health FSA (or on
account of a change in cost or coverage
under a health FSA).

(2) Cost changes - - (i) Automatic
changes. If the cost of a qualified benefits
plan increases (or decreases) during a
period of coverage and, under the terms of
the plan, employees are required to make
a corresponding change in their payments,
the cafeteria plan may, on a reasonable
and consistent basis, automatically make
a prospective increase (or decrease) in
affected employees' elective contributions
for the plan.

(ii) Significant cost changes. If the
cost charged to an employee for a benefit
package option (as defined in paragraph
(i)(2) of this section) significantly increas-
es or significantly decreases during a peri-
od of coverage, the cafeteria plan may
permit the employee to make a corre-
sponding change in election under the
cafeteria plan. Changes that may be made

include commencing participation in the
cafeteria plan for the option with a
decrease in cost, or, in the case of an
increase in cost, revoking an election for
that coverage and, in lieu thereof, either
receiving on a prospective basis coverage
under another benefit package option pro-
viding similar coverage or dropping cov-
erage if no other benefit package option
providing similar coverage is available.
For example, if the cost of an indemnity
option under an accident or health plan
significantly increases during a period of
coverage, employees who are covered by
the indemnity option may make a corre-
sponding prospective increase in their
payments or may instead elect to revoke
their election for the indemnity option
and, in lieu thereof, elect coverage under
another benefit package option including
an HMO option (or drop coverage under
the accident or health plan if no other ben-
efit package option is offered).

(iii) Application of cost changes. For
purposes of paragraphs (f)(2)(i) and (ii) of
this section, a cost increase or decrease
refers to an increase or decrease in the
amount of the elective contributions under
the cafeteria plan, whether that increase or
decrease results from an action taken by
the employee (such as switching between
full-time and part-time status) or from an
action taken by an employer (such as
reducing the amount of employer contri-
butions for a class of employees).

(iv) Application to dependent care.
This paragraph (f)(2) applies in the case
of a dependent care assistance plan only if
the cost change is imposed by a dependent
care provider who is not a relative of the
employee. For this purpose, a relative is
an individual who is related as described
in section 152(a)(1) through (8), incorpo-
rating the rules of section 152(b)(1) and
(2).

(3) Coverage changes - - (i) Significant
curtailment without loss of coverage. If
an employee (or an employee's spouse or
dependent) has a significant curtailment
of coverage under a plan during a period
of coverage that is not a loss of coverage
as described in paragraph (f)(3)(ii) of this
section (for example, there is a significant
increase in the deductible, the copay, or
the out-of-pocket cost sharing limit under
an accident or health plan), the cafeteria
plan may permit any employee who had

been participating in the plan and receiv-
ing that coverage to revoke his or her
election for that coverage and, in lieu
thereof, to elect to receive on a prospec-
tive basis coverage under another benefit
package option providing similar cover-
age. Coverage under a plan is signifi-
cantly curtailed only if there is an overall
reduction in coverage provided under the
plan so as to constitute reduced coverage
generally. Thus, in most cases, the loss of
one particular physician in a network
does not constitute a significant curtail-
ment.

(ii) Significant curtailment with loss of
coverage. If an employee (or the employ-
ee's spouse or dependent) has a signifi-
cant curtailment that is a loss of coverage,
the plan may permit that employee to
revoke his or her election under the cafe-
teria plan and, in lieu thereof, to elect
either to receive on a prospective basis
coverage under another benefit package
option providing similar coverage or to
drop coverage if no similar benefit pack-
age option is available. For purposes of
this paragraph (f)(3)(ii), a loss of coverage
means a complete loss of coverage under
the benefit package option or other cover-
age option (including the elimination of a
benefits package option, an HMO ceasing
to be available in the area where the indi-
vidual resides, or the individual losing all
coverage under the option by reason of an
overall lifetime or annual limitation). In
addition, the cafeteria plan may, in its dis-
cretion, treat the following as a loss of
coverage - -

(A) A substantial decrease in the med-
ical care providers available under the
option (such as a major hospital ceasing to
be a member of a preferred provider net-
work or a substantial decrease in the
physicians participating in a preferred
provider network or an HMO);

(B) A reduction in the benefits for a
specific type of medical condition or
treatment with respect to which the
employee or the employee's spouse or
dependent is currently in a course of treat-
ment; or

(iii) Addition or improvement of a ben-
efit package option . If a plan adds a new
benefit package option or other coverage
option, or if coverage under an existing

benefit package option or other coverage
option is significantly improved during a
period of coverage, the cafeteria plan may
permit eligible employees (whether or not
they have previously made an election
under the cafeteria plan or have previous-
ly elected the benefit package option) to
revoke their election under the cafeteria
plan and, in lieu thereof, to make an elec-
tion on a prospective basis for coverage
under the new or improved benefit pack-
age option.

(4) Change in coverage under another
employer plan. A cafeteria plan may per-
mit an employee to make a prospective
election change that is on account of and
corresponds with a change made under
another employer plan (including a plan
of the same employer or of another
employer) if - -

(i) The other cafeteria plan or qualified
benefits plan permits participants to make
an election change that would be permit-
ted under paragraphs (b) through (g) of
this section (disregarding this paragraph
(f)(4)); or

(ii) The cafeteria plan permits partici-
pants to make an election for a period of
coverage that is different from the period
of coverage under the other cafeteria plan
or qualified benefits plan.

(5) Loss of coverage under other
group health coverage. A cafeteria plan
may permit an employee to make an
election on a prospective basis to add
coverage under a cafeteria plan for the
employee, spouse, or dependent if the
employee, spouse, or dependent loses
coverage under any group health cover-
age sponsored by a governmental or edu-
cational institution, including the follow-
ing - -

(i) A State's children's health insurance
program (SCHIP) under Title XXI of the
Social Security Act;

(ii) A medical care program of an
Indian Tribal government (as defined in
section 7701(a)(40)), the Indian Health
Service, or a tribal organization

(iii) A State health benefits risk pool; or

(iv) A Foreign government group health
plan.

(6) Examples. The following examples
illustrate the application of this paragraph
(f):

Example 1. (i) A calendar year cafeteria plan is
maintained pursuant to a collective bargaining
agreement for the benefit of Employer M's employ-

ees. The cafeteria plan offers various benefits,
including indemnity health insurance and a health
FSA. As a result of mid-year negotiations, premi-
ums for the indemnity health insurance are reduced
in the middle of the year, insurance co-payments for
office visits are reduced under the indemnity plan by
an amount which constitutes a significant benefit
improvement, and an HMO option is added.

(ii) Under these facts, the reduction in health
insurance premiums is a reduction in cost.
Accordingly, under paragraph (f)(2)(i) of this sec-
tion, the cafeteria plan may automatically decrease
the amount of salary reduction contributions of
affected participants by an amount that corresponds
to the premium change. However, the plan may not
permit employees to change their health FSA elec-
tions to reflect the mid-year change in copayments
under the indemnity plan.

(iii) Also, the decrease in co-payments is a signif-
icant benefit improvement and the addition of the
HMO option is an addition of a benefit package
option. Accordingly, under paragraph (f)(3)(ii) of
this section, the cafeteria plan may permit eligible
employees to make an election change to elect the
indemnity plan or the new HMO option. However,
the plan may not permit employees to change their
health FSA elections to reflect differences in co-pay-
ments under the HMO option.

Example 2. (i) Employer N sponsors an accident
or health plan under which employees may elect
either employee-only coverage or family health cov-
erage. The 12-month period of coverage under N's
cafeteria plan begins January 1, 2001. N's employee,
A, is married to B. Employee A elects employee-only
coverage under N's plan. B's employer, O, offers
health coverage to O's employees under its accident
or health plan under which employees may elect
either employee-only coverage or family coverage.
O's plan has a 12-month period of coverage begin-
ning September 1, 2001. B maintains individual cov-
erage under O's plan at the time A elects coverage
under N's plan, and wants to elect no coverage for the
plan year beginning on September 1, 2001, which is
the next period of coverage under O's accident or
health plan. A certifies to N that B will elect no cov-
erage under O's accident or health plan for the plan
year beginning on September 1, 2001 and N has no
reason to believe that A's certification is incorrect.

(ii) Under paragraph (f)(4)(ii) of this section, N's
cafeteria plan may permit A to change A's election
prospectively to family coverage under that plan
effective September 1, 2001.

Example 3. (i) Employer P sponsors a calendar
year cafeteria plan under which employees may elect
either employee-only or family health coverage.
Before the beginning of the year, P's employee, C,
elects family coverage under P's cafeteria plan. C
also elects coverage under the health FSA for up to
$200 of reimbursements for the year to be funded by
salary reduction contributions of $200 during the
year. C is married to D, who is employed by
Employer Q. Q does not maintain a cafeteria plan,
but does maintain an accident or health plan provid-
ing its employees with employee-only coverage.
During the calendar year, Q adds family coverage as
an option under its health plan. D elects family cov-
erage under Q's plan, and C wants to revoke C's
election for health coverage and elect no health cov-
erage under P's cafeteria plan for the remainder of
the year.

(ii) Q's addition of family coverage as an option
under its health plan constitutes a new coverage
option described in paragraph (f)(3)(ii) of this sec-
tion. Accordingly, pursuant to paragraph (f)(4)(i) of
this section, P's cafeteria plan may permit C to
revoke C's health coverage election if D actually
elects family health coverage under Q's accident or
health plan. Employer P's plan may not permit C to
change C's health FSA election.

Example 4. (i) Employer R maintains a cafeteria
plan under which employees may elect accident or
health coverage under either an indemnity plan or an
HMO. Before the beginning of the year, R's
employee, E elects coverage under the HMO at a
premium cost of $100 per month. During the year,
E decides to switch to the indemnity plan, which
charges a premium of $140 per month.

(ii) E's change from the HMO to indemnity plan
is not a change in cost or coverage under this para-
graph (f), and none of the other election change rules
under paragraphs (b) through (e) of this section
apply.

(iii) Although R's health plan may permit E to
make the change from the HMO to the indemnity
plan, R's cafeteria plan may not permit E to make an
election change to reflect the increased premium.
Accordingly, if E switches from the HMO to the
indemnity plan, E may pay the $40 per month addi-
tional cost on an after-tax basis.

Example 5. (i) Employee A is married to
Employee B and they have one child, C. Employee
A's employer, M, maintains a calendar year cafeteria
plan that allows employees to elect coverage under a
dependent care FSA. Child C attends X's on site
child care center at an annual cost of $3,000. Prior
to the beginning of the year, A elects salary reduction
contributions of $3,000 during the year to fund cov-
erage under the dependent care FSA for up to $3,000
of reimbursements for the year. Employee A now
wants to revoke A's election of coverage under the
dependent care FSA, because A has found a new
child care provider.

(ii) The availability of dependent care services
from the new child care provider (whether the new
provider is a household employee or family member
of A or B or a person who is independent of A and B)
is a significant change in coverage similar to a ben-
efit package option becoming available. Because
the FSA is a dependent care FSA rather than a health
FSA, the coverage rules of this section apply and
M's cafeteria plan may permit A to elect to revoke
A's previous election of coverage under the depen-
dent care FSA, and make a corresponding new elec-
tion to reflect the cost of the new child care provider.

Example 6. (i) Employee D is married to
Employee E and they have one child, F. Employee
D's employer, N, maintains a calendar year cafeteria
plan that allows employees to elect coverage under a
dependent care FSA. Child F is cared for by Y, D's
household employee, who provides child care ser-
vices five days a week from 9 a.m. to 6 p.m. at an
annual cost in excess of $5,000. Prior to the begin-
ning of the year, D elects salary reduction contribu-
tions of $5,000 during the year to fund coverage
under the dependent care FSA for up to $5,000 of
reimbursements for the year. During the year, F
begins school and, as a result, Y's regular hours of
work are changed to five days a week from 3 p.m. to
6 p.m. Employee D now wants to revoke D's elec-
tion under the dependent care FSA, and make a new

election under the dependent care FSA to an annual
cost of $4,000 to reflect a reduced cost of child care
due to Y's reduced hours.

(ii) The change in the number of hours of work
performed by Y is a change in coverage. Thus, N's
cafeteria plan may permit D to reduce D's previ-
ous election under the dependent care FSA to
$4,000.

Example 7. (i) Employee G is married to
Employee H and they have one child, J. Employee
G's employer, O, maintains a calendar year cafeteria
plan that allows employees to elect coverage under a
dependent care FSA. Child J is cared for by Z, G's
household employee, who is not a relative of G and
who provides child care services at an annual cost of
$4,000. Prior to the beginning of the year, G elects
salary reduction contributions of $4,000 during the
year to fund coverage under the dependent care FSA
for up to $4,000 of reimbursements for the year.
During the year, G raises Z's salary. Employee G
now wants to revoke G's election under the depen-
dent care FSA, and make a new election under the
dependent care FSA to an annual amount of $4,500
to reflect the raise.

(ii) The raise in Z's salary is a significant increase
in cost under paragraph (f)(2)(ii) of this section, and
an increase in election to reflect the raise corre-
sponds with that change in status. Thus, O's cafete-
ria plan may permit G to elect to increase G's elec-
tion under the dependent care FSA.

Example 8. (i) Employer P maintains a calendar
year cafeteria plan that allows employees to elect
employee-only, employee plus one dependent, or
family coverage under an indemnity plan. During
the middle of the year, Employer P gives its employ-
ees the option to select employee-only or family
coverage from an HMO plan. P's employee, J, who
had elected employee plus one dependent coverage
under the indemnity plan, decides to switch to fami-
ly coverage under the HMO plan.

(ii) Employer P's midyear addition of the HMO
option is an addition of a benefit package option.
Under paragraph (f) of this section, Employee J may
change his or her salary reduction contributions to
reflect the change from indemnity to HMO cover-
age, and also to reflect the change from employee
plus one dependent to family coverage (however, an
election of employee-only coverage under the new
option would not correspond with the addition of a
new option). Employer P may not permit J to
change J's health FSA election.

(g) Special requirements relating to the
Family and Medical Leave Act. An
employee taking leave under the Family
and Medical Leave Act (FMLA) (Public
Law 103-3 (107 Stat. 6)) may revoke an
existing election of accident or health plan
coverage and make such other election for
the remaining portion of the period of
coverage as may be provided for under
the FMLA.

* * * * *

(i) * * *

(3) Dependent. A dependent means a
dependent as defined in section 152,
except that, for purposes of accident or
health coverage, any child to whom sec-

tion 152(e) applies is treated as a depen-
dent of both parents, and, for purposes of
dependent care assistance provided
through a cafeteria plan, a dependent
means a qualifying individual (as defined
in section 21(b)(1)) with respect to the
employee.

(4) Disability coverage. Disability
coverage means coverage under an acci-
dent or health plan that provides benefits
due to personal injury or sickness, but
does not reimburse expenses incurred for
medical care (as defined in section
213(d)) of the employee or the employ-
ee's spouse and dependents. For purpos-
es of this section, disability coverage
includes payments described in section
105(c).

* * * * *

(8) Qualified benefits plan. * * * A
plan does not fail to be a qualified benefits
plan merely because it includes an FSA,
assuming that the FSA meets the require-
ments of section 125 and the regulations
thereunder.

(9) Similar coverage. Coverage for the
same category of benefits for the same
individuals (e.g., family to family or sin-
gle to single). For example, two plans
that provide coverage for major medical
are considered to be similar coverage. For
purposes of this definition, a health FSA is
not similar coverage with respect to an
accident or health plan that is not a health
FSA. A plan may treat coverage by anoth-
er employer, such as a spouse's or depen-
dent's employer, as similar coverage.

(j) Effective date - (1) General rule.
Except as provided in paragraph (j)(2) of
this section, this section is applicable for
cafeteria plan years beginning on or after
January 1, 2001.

(2) Delayed effective date for certain
provisions. The following provisions are
applicable for cafeteria plan years begin-
ning on or after January 1, 2002: paragraph
(c) of this section to the extent applicable to
qualified benefits other than an accident or
health plan or a group-term life insurance
plan; paragraph (d)(1)(ii)(B) of this section
(relating to a spouse, former spouse, or
other individual obtaining accident or
health coverage for an employee's child in
response to a judgment, decree, or order);
paragraph (f) of this section (rules for elec-
tion changes as a result of cost or coverage
changes); and paragraph (i)(9) of this sec-
tion (defining similar coverage).

1.125-4T [Removed]

Par. 3. Section 1.125-4T is removed.

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.

Approved December 15, 2000.

Jonathan Talisman,
Acting Assistant Secretary of
the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on Janu-
ary 9, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 10, 2001, 66 F.R.
1837)

#### Section 280G .- Golden Parachute Payments

Federal short-term, mid-term, and long-term
rates are set forth for the month of February 2001.
See Rev. Rul. 2001-7, page 541.

#### Section 382 .- Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is
set forth for the month of February 2001. See Rev.
Rul. 2001-7, page 541.

## Section 412 .- Minimum Funding Standards

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

## Section 467 .- Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

26 CFR 1.467-2: Rent accrual for section 467
rental agreements without adequate interest.

T.D. 8917

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

## Section 467 Rental Agreements Involving Payments of $2,000,000 or Less

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains
final regulations concerning section 467
rental agreements. The regulations pro-
vide amendments to the regulations under
section 467, including the removal of the
exception to constant rental accrual for
rental agreements involving payments of
$2,000,000 or less. The regulations affect
taxpayers that are parties to a section 467
rental agreement.

DATES: Effective Date: These regula-
tions are effective January 5, 2001.

Dates of Applicability: For dates of
applicability of these regulations, see
Effective Dates under SUPPLEMEN-
TARY INFORMATION.

FOR FURTHER INFORMATION CON-
TACT: Forest Boone, (202) 622-4960 (not
a toll-free number).

SUPPLEMENTARY INFORMATION:

### Background

This document contains amendments to
26 CFR Part 1 under section 467 of the
Internal Revenue Code (Code). Section
467 was added to the Code by section
92(a) of the Tax Reform Act of 1984
(Public Law 98-369; 98 Stat. 609).

On May 18, 1999, a notice of proposed
rulemaking (REG-103694-99, 1999-1,
C.B. 49) under section 467 was published
in the Federal Register (64 F.R. 26924).
The notice proposed to amend the section
467 regulations relating to constant rental
accrual by treating section 467 rental
agreements involving payments of
$2,000,000 or less in the same manner as
agreements involving payments of more
than $2,000,000. Although comments
and requests for a public hearing were
solicited, no comments were received and
no public hearing was requested or held.
Accordingly, the amendment to the con-
stant rental accrual rules called for by the
proposed regulations is adopted without
revision.

In addition, the IRS and Treasury
Department have identified three provi-

sions in the section 467 regulations (T.D.
8820, 1999-1 C.B. 1209), published on
May 18, 1999, at 64 F.R. 26845, that
require clarification. Accordingly, these
final regulations also provide clarifying
amendments to the section 467 regula-
tions.

### Explanation of Provisions

#### A. Removal of the $2,000,000 Constant Rental Accrual Exception

Section 467 includes an anti-abuse rule
applicable to certain section 467 rental
agreements. Under this rule, a constant
rental amount must be taken into account
by a lessor and lessee for each rental peri-
od during the lease term. The constant
rental amount is the amount that, if paid at
the end of each rental period, would result
in a present value equal to the present
value of all amounts payable under the
agreement.

Constant rental accrual applies only
with respect to leasebacks and long-term
agreements that provide for increasing or
decreasing rent and only if the
Commissioner determines that the agree-
ment is disqualified because tax avoid-
ance is a principal purpose for providing
increasing or decreasing rent. In addition,
however, the regulations provide that a
rental agreement will not be disqualified
and, consequently, will not be subject to
constant rental accrual unless it requires
more than $2,000,000 in rental payments
and other consideration.

These final regulations remove the
$2,000,000 exception from constant
rental accrual for section 467 rental
agreements entered into on or after July
19, 1999. Consequently, for section 467
rental agreements entered into on or after
July 19, 1999, the Commissioner may
determine that the agreement is a disqual-
ified leaseback or long-term agreement
subject to constant rental accrual, even if
the agreement requires $2,000,000 or less
in rental payments and other considera-
tion.

#### B. Definition of Lease Term

Section 1.467-1(h)(6) defines lease
term to mean "the period during which
the lessee has use of the property subject
to the rental agreement, including any
option to renew or extend the term of the
agreement other than an option, exercis-

able by the lessee, as to which it is rea-
sonably expected, as of the agreement
date, that the option will not be exer-
cised." [Emphasis added]. By contrast,
the proposed regulations preceding the
section 467 final regulations stated that
an option period, whether exercisable by
the lessor or lessee, is included in the
lease term only if it is expected, as of the
agreement date, that the option will be
exercised. The purpose of the broader
rule in the final regulations was to
include all lessor option periods in the
lease term. The IRS and Treasury
Department recognize, however, that the
broader rule has caused some uncertain-
ty as to whether a change in the treatment
of lessee options, particularly those
exercisable at fair market value rental,
was also intended. These regulations
clarify that a change in the treatment of
lessee options was not intended. They
provide, in language similar to that of the
proposed section 467 regulations, that
lessee options are to be included in the
lease term only if it is expected, as of the
agreement date, that the option will be
exercised. For this purpose, a lessee is
generally expected to exercise an option
if, for example, as of the agreement date
the rent for the option period is less than
the expected fair market value rental for
such period. It should be noted, howev-
er, that factors other than the relationship
between rent and expected fair market
value rental for the option period may be
relevant in determining whether it is
expected that a lessee option will be
exercised. Thus, even in the case of a
lessee option exercisable at fair market
value rental, it may, on account of such
other relevant factors, be expected that
the option will be exercised.

#### C. When an Amount is Considered Payable

Section 1.467-1(j)(2)(ii) provides that,
for purposes of determining present value
and yield under the regulations, an
amount is payable on the last day for
timely payment (the last day for timely
payment rule). The last day for timely
payment is the last day such amount may
be paid without incurring interest, com-
puted at an arm's-length rate, a substantial
penalty, or other substantial detriment
(such as giving the lessor the right to ter-
minate the agreement, bring an action to

enforce payment, or exercise other similar
remedies under the terms of the agree-
ment or applicable law).

The IRS and Treasury Department
believe that the last day for timely pay-
ment rule, applicable to the computation
of present value and yield, should also
apply to other cases in which the date on
which an amount is payable is relevant for
purposes of section 467. Accordingly, the
section 467 regulations have been amend-
ed to provide that, for purposes of apply-
ing all of the section 467 rules, not just
those dealing with present value and
yield, an amount is payable on the last day
for timely payment.

#### D. Adequate Interest for Agreements With Both Deferred and Prepaid Rent

Under the section 467 regulations, the
fixed rent for each rental period is the pro-
portional rental amount if the section 467
rental agreement is not a disqualified
leaseback or long-term agreement and if
the agreement does not provide adequate
interest on fixed rent. The regulations set
forth rules for determining whether an
agreement has adequate interest on fixed
rent. These regulations clarify how these
rules apply in the case of agreements with
both deferred and prepaid rent.

#### E. Effective Dates

The removal of the exception from
constant rental accrual for rental agree-
ments involving payments of $2,000,000
or less is applicable for section 467 rental
agreements entered into on or after July
19, 1999. The other amendments in
these regulations are applicable to rental
agreements entered into after March 6,
2001. However, taxpayers may choose
to apply these amendments to rental
agreements entered into on or before
March 6, 2001.

### Special Analyses

Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its impact
on small business.

### Drafting Information

The principal author of the regulations
is Forest Boone, Office of Associate Chief
Counsel (Income Tax and Accounting).
However, other personnel from the IRS
and Treasury Department participated in
the development of the regulations.

\*
\*
\*

\*
\*

### Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended
as follows:

PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

Par 2. Section 1.467-0 is amended by
adding an entry for §1.467-2(b)(3) to read
as follows:

§1.467-0 Table of contents.

\*
\*

\*
\*
\*

§1.467-2 Rent accrual for section 467
rental agreements without adequate
interest.

\*
\*

(b)
*

(3) Agreements with both deferred and
prepaid rent.

\*
\*

\*
\*
\*

Par 3. Section 1.467-1 is amended by
revising paragraphs (h)(6) and (j)(2)(ii) to
read as follows:

§1.467-1 Treatment of lessors and
lessees generally.

\*
\*

(h)
*

(6) Lease term means the period during
which the lessee has use of the property
subject to the rental agreement, including
any option of the lessor to renew or
extend the term of the agreement. An
option of the lessee to renew or extend the

term of the agreement is included in the
lease term only if it is expected, as of the
agreement date, that the option will be
exercised. For this purpose, a lessee is
generally expected to exercise an option
if, for example, as of the agreement date
the rent for the option period is less than
the expected fair market value rental for
such period. The lessor's or lessee's
determination that an option period is
either included in or excluded from the
lease term is not binding on the
Commissioner. If the lessee (or a related
person) agrees that one or both of them
will or could be obligated to make pay-
ments in the nature of rent (within the
meaning of §1.168(i)-2(b)(2)) for a peri-
od when another lessee (the substitute
lessee) or the lessor will have use of the
property subject to the rental agreement,
the Commissioner may, in appropriate
cases, treat the period when the substitute
lessee or lessor will have use of the prop-
erty as part of the lease term. See
§1.467-7(f) for special rules applicable to
the lessee, substitute lessee, and lessor.
This paragraph (h)(6) applies to section
467 rental agreements entered into after
March 6, 2001. However, taxpayers may
choose to apply this paragraph (h)(6) to
any rental agreement that is described in
§1.467-9(a) and is entered into on or
before March 6, 2001.

\*
\*

\*
\*
\*

(j)
(2)

(ii) Time amount is payable. For pur-
poses of this section and §§1.467-2
through 1.467-9, an amount is payable on
the last day for timely payment (that is,
the last day such amount may be paid
without incurring interest, computed at an
arm's-length rate, a substantial penalty, or
other substantial detriment (such as giving
the lessor the right to terminate the agree-
ment, bring an action to enforce payment,
or exercise other similar remedies under
the terms of the agreement or applicable
law)). This paragraph (j)(2)(ii) applies to
section 467 rental agreements entered into
after March 6, 2001. However, taxpayers
may choose to apply this paragraph
(j)(2)(ii) to any rental agreement that is
described in §1.467-9(a) and is entered
into on or before March 6, 2001.
*
*
*
*
*

Par 4. In §1.467-2, paragraph (b)(3) is
added to read as follows:

§1.467-2 Rent accrual for section 467
rental agreements without adequate
interest.

\*
\*
\*
\*
\*

(b)

(3) Agreements with both deferred and
prepaid rent. If an agreement has both
deferred and prepaid rent, the agreement
provides adequate interest under paragraph
(b)(1) of this section if the conditions set
forth in paragraph (b)(1)(ii)(A) through (D)
of this section are met for both the prepaid
and the deferred rent. For purposes of this
paragraph (b)(3), an agreement will be con-
sidered to meet the condition set forth in
paragraph (b)(1)(ii)(A) of this section if the
agreement provides a single fixed rate of
interest on the deferred rent and a single
fixed rate of interest on the prepaid rent,
even if those rates are not the same. This
paragraph (b)(3) applies to section 467
rental agreements entered into after March
6, 2001. However, taxpayers may choose
to apply this paragraph (b)(3) to any rental
agreement that is described in §1.467-9(a)
and is entered into on or before March 6,
2001.

\*
\*
\*

\*
\*

Par 5. In §1.467-3, paragraph
(b)(1)(iii) is revised to read as follows:

§1.467-3 Disqualified leasebacks and
long-term agreements.

\*
\*

(b) * * * (1) * * *

(iii) For section 467 rental agreements
entered into before July 19, 1999, the
amount determined with respect to the
rental agreement under §1.467-1(c)(4)
(relating to the exception for rental agree-
ments involving total payments of
$250,000 or less) exceeds $2,000,000.
*
*

\*
\*

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.

Approved December 12, 2000.

Jonathan Talisman,
Acting Assistant Secretary of
the Treasury.

(Filed by the Office of the Federal Register on Janu-
ary 4, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 5, 2001, 66 F.R.
1038)

# Section 468 .- Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, on this page.

## Section 482 .- Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term
rates are set forth for the month of February 2001.
See Rev. Rul. 2001-7, on this page.

## Section 483 .- Interest on Certain Deferred Payments

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, on this page.

## Section 642 .- Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term
rates are set forth for the month of February 2001.
See Rev. Rul. 2001-7, on this page.

## Section 807 .- Rules for Certain Reserves

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, on this
page.

## Section 846 .- Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, on this
page.

### Section 1274 .- Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property

(Also sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates;
adjusted federal long-term rate, and
the long-term exempt rate. For purposes
of sections 382, 1274, 1288, and other
sections of the Code, tables set forth the
rates for February 2001.

This revenue ruling provides various
prescribed rates for federal income tax
purposes for February 2001 (the current
month). Table 1 contains the short-term,
mid-term, and long-term applicable fed-
eral rates (AFR) for the current month
for purposes of section 1274(d) of the
Internal Revenue Code. Table 2 con-
tains the short-term, mid-term, and long-
term adjusted applicable federal rates
(adjusted AFR) for the current month for
purposes of section 1288(b). Table 3
sets forth the adjusted federal long-term
rate and the long-term tax-exempt rate
described in section 382(f). Table 4 con-
tains the appropriate percentages for
determining the low-income housing
credit described in section 42(b)(2) for
buildings placed in service during the
current month. Finally, Table 5 contains
the federal rate for determining the pre-
sent value of an annuity, an interest for
life or for a term of years, or a remainder
or a reversionary interest for purposes of
section 7520.

REV. RUL. 2001-7 TABLE 1 Applicable Federal Rates (AFR) for February 2001 Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-Term

AFR

5.18%

5.11%

5.08%

5.06%

110% AFR

5.70%

5.62%

5.58%

5.56%

120% AFR

6.22%

6.13%

6.08%

6.05%

130% AFR

6.75%

6.64%

6.59%

6.55%

Mid-Term

AFR

5.07%

5.01%

4.98%

4.96%

110% AFR

5.59%

5.51%

5.47%

5.45%

120% AFR

6.10%

6.01%

5.97%

5.94%

130% AFR

6.62%

6.51%

6.46%

6.42%

150% AFR

7.66%

7.52%

7.45%

7.40%

175% AFR

8.96%

8.77%

8.68%

8.61%

Long-Term

AFR

5.48%

5.41%

5.37%

5.35%

110% AFR

6.04%

5.95%

5.91%

5.88%

120% AFR

6.60%

6.49%

6.44%

6.40%

130% AFR

7.15%

7.03%

6.97%

6.93%

REV. RUL. 2001-7 TABLE 2 Adjusted AFR for February 2001 Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-term adjusted AFR Mid-term adjusted AFR Long-term adjusted AFR

3.91%

3.87%

3.85%

3.84%

4.25%

4.21%

4.19%

4.17%

4.92%

4.86%

4.83%

4.81%

REV. RUL. 2001-7 TABLE 3
Rates Under Section 382 for February 2001

#### Adjusted federal long-term rate for the current month 4.92%

Long-term tax-exempt rate for ownership changes during
the current month (the highest of the adjusted federal long-term
rates for the current month and the prior two months.)

5.31%

## REV. RUL. 2001-7 TABLE 4 Appropriate Percentages Under Section 42(b)(2) for February 2001

Appropriate percentage for the 70% present value low-income housing credit

8.23%

Appropriate percentage for the 30% present value low-income housing credit

3.53%

### REV. RUL. 2001-7 TABLE 5 Rate Under Section 7520 for February 2001

Applicable federal rate for determining the present value of an annuity,
an interest for life or a term of years, or a remainder or reversionary interest

6.2%

#### Section 1288 .- Treatment of Original Issue Discounts on Tax- Exempt Obligations

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

#### Section 7520 .- Valuation Tables

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

#### Section 7872 .- Treatment of Loans With Below-Market Interest Rates

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2001. See Rev. Rul. 2001-7, page 541.

Section 9802 .- Prohibiting
Discrimination Against Individual
Participants and Beneficiaries
Based on Health Status

26 CFR 54.9802-1T: Prohibiting disrimination
against participants and beneficiaries based on a
health factor (temporary)

T.D. 8931

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 54

DEPARTMENT OF LABOR
Pension and Welfare Benefits
Administration
29 CFR Part 2590

DEPARTMENT OF HEALTH AND
HUMAN SERVICES
Health Care Financing
Administration
45 CFR Part 146

##### Interim Final Rules for Nondiscrimination in Health Coverage in the Group Market

AGENCIES: Internal Revenue Service,
Department of the Treasury; Pension and
Welfare Benefits Administration,
Department of Labor; Health Care
Financing Administration, Department of
Health and Human Services.

ACTION: Interim final rules with request
for comments.

SUMMARY: This document contains
interim final rules governing the provi-
sions prohibiting discrimination based on
a health factor for group health plans and
issuers of health insurance coverage
offered in connection with a group health
plan. The rules contained in this docu-
ment implement changes made to the
Internal Revenue Code of 1986 (Code),
the Employee Retirement Income
Security Act of 1974 (ERISA), and the
Public Health Service Act (PHS Act)
enacted as part of the Health Insurance
Portability and Accountability Act of
1996 (HIPAA).

DATES: Effective date. The interim final
rules are effective March 9, 2001.

Applicability dates. For rules describ-
ing when this section applies to group
health plans and group health insurance
issuers, see paragraph (i) of these interim
regulations.1

Comment date. Written comments on
these interim regulations are invited and
must be received by the Departments on
or before April 9, 2001.

ADDRESSES: Written comments should
be submitted with a signed original and
three copies (except for electronic sub-

missions to the Internal Revenue Service
(IRS) or Department of Labor) to any of
the addresses specified below. Any com-
ment that is submitted to any Department
will be shared with the other Departments.

Comments to the IRS can be addressed
to:

CC:M&SP:RU (REG-109707-97)
Room 5226
Internal Revenue Service
POB 7604, Ben Franklin Station
Washington, DC 20044

In the alternative, comments may be
hand-delivered between the hours of 8
a.m. and 5 p.m. to:

CC:M&SP:RU (REG-109707-97)

Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, NW.
Washington, DC 20224

Alternatively, comments may be trans-
mitted electronically via the IRS Internet
site at:

http://www.irs.gov/tax_regs/regslist.html.

Comments to the Department of Labor
can be addressed to:

U.S. Department of Labor
Pension and Welfare Benefits
Administration
200 Constitution Avenue NW.,
Room C-5331
Washington, DC 20210
Attention: Nondiscrimination Comments

Alternatively, comments may be hand-
delivered between the hours of 9 a.m. and
5 p.m. to the same address. Comments
may also be transmitted by e-mail to:
HIPAA702@pwba.dol.gov.

Comments to HHS can be addressed to:
Health Care Financing Administration
Department of Health and Human Services
Attention: HCFA-2022-IFC
P.O. Box 26688
Baltimore, MD 21207

In the alternative, comments may be
hand-delivered between the hours of 8:30
a.m. and 5 p.m. to either:

Room 443-G
Hubert Humphrey Building
200 Independence Avenue, SW.
Washington, DC 20201

or
Room C5-14-03
7500 Security Boulevard
Baltimore, MD 21244-1850

All submissions to the IRS will be open
to public inspection and copying in room
1621, 1111 Constitution Avenue, NW.,
Washington, DC, from 9 a.m. to 4 p.m.

All submissions to the Department of
Labor will be open to public inspection
and copying in the Public Documents
Room, Pension and Welfare Benefits
Administration, U.S. Department of
Labor, Room N-1513, 200 Constitution
Avenue, NW., Washington, DC, from 8:30
a.m. to 5:30 p.m.

All submissions to HHS will be open to
public inspection and copying in room
309-G of the Department of Health and
Human Services, 200 Independence
Avenue, SW., Washington, DC, from 8:30
a.m. to 5 p.m.

FOR FURTHER INFORMATION
CONTACT: Russ Weinheimer, Internal
Revenue Service, Department of the
Treasury, at (202) 622-6080; Amy J.
Turner, Pension and Welfare Benefits
Administration, Department of Labor, at
(202) 219-7006; or Ruth A. Bradford,
Health Care Financing Administration,
Department of Health and Human
Services, at (410) 786-1565.

CUSTOMER SERVICE INFORMA-

TION: Individuals interested in obtaining
additional information on HIPAA's nondis-
crimination rules may request a copy of the
Department of Labor's booklet entitled
"Questions and Answers: Recent Changes
in Health Care Law" by calling the PWBA
Toll-Free Publication Hotline at 1-800-998-
7542 or may request a copy of the Health
Care Financing Administration's new pub-
lication entitled "Protecting Your Health
Insurance Coverage" by calling (410) 786-
1565. Information on HIPAA's nondis-
crimination rules and other recent health
care laws is also available on the
Department of Labor's website
(http://www.dol.gov/dol/pwba) and the
Department of Health and Human
Services' website (http://hipaa.hcfa.gov).

# SUPPLEMENTARY INFORMATION:

I. Background

The Health Insurance Portability and
Accountability Act of 1996 (HIPAA),
Public Law 104-191, was enacted on
August 21, 1996. HIPAA amended the
Internal Revenue Code of 1986 (Code),

1 Reference in this preamble to a specific paragraph
in the interim regulations are to paragraphs in each of
the three sets of regulations being published as part
of this document. Specifically, references are to para-
graphs in 26 CFR 54.9802-1 and 26 CFR
54.9802-1T(see discussion and table in "C. Format
of Regulations" below), 29 CFR 2590.702, and 45
CFR 146.121.

the Employee Retirement Income
Security Act of 1974 (ERISA), and the
Public Health Service Act (PHS Act) to
provide for, among other things, improved
portability and continuity of health cover-
age. HIPAA added section 9802 of the
Code, section 702 of ERISA, and section
2702 of the PHS Act, which prohibit dis-
crimination in health coverage. Interim
final rules implementing the HIPAA pro-
visions were first made available to the
public on April 1, 1997 (published in the
Federal Register on April 8, 1997, 62
F.R. 16894) (April 1997 interim rules).
On December 29, 1997, the Departments
published a clarification of the April 1997
interim rules as they relate to individuals
who were denied coverage before the
effective date of HIPAA on the basis of
any health factor (62 F.R. 67689).

In the preamble to the April 1997 inter-
im rules, the Departments invited com-
ments on whether additional guidance
was needed concerning -

· The extent to which the statute
prohibits discrimination against in-
dividuals in eligibility for particu-
lar benefits;

· The extent to which the statute
may permit benefit limitations
based on the source of an injury;

· The permissible standards for
defining groups of similarly situ-
ated individuals;

· Application of the prohibitions on
discrimination between groups of
similarly situated individuals; and

· The permissible standards for de-
termining bona fide wellness programs.
In the preamble to the April 1997 interim
rules, the Departments stated that they in-
tend to issue further regulations on the
nondiscrimination rules and that in no
event would the Departments take any en-
forcement action against a plan or issuer
that had sought to comply in good faith
with section 9802 of the Code, section 702
of ERISA, and section 2702 of the PHS
Act before the additional guidance is pro-
vided. Accordingly, with the issuance of
these interim regulations, the Departments
have determined that the period for nonen-
forcement in cases of good faith compli-
ance ends in accordance with the rules de-
scribed in paragraph (i) of these interim
regulations.2 However, because the in-

2 See footnote 1.

terim regulations do not include a discus-
sion of bona fide wellness programs (see
proposed regulations REG-114084-00 re-
lating to bona fide wellness programs on
page 633 of this Bulletin), the period for
good faith compliance continues with re-
spect to those provisions until further
guidance is issued.

## II. Overview of the Regulations

Section 9802 of the Code, section 702
of ERISA, and section 2702 of the PHS
Act (the HIPAA nondiscrimination pro-
visions) establish rules generally pro-
hibiting group health plans and group
health insurance issuers from discrimi-
nating against individual participants or
beneficiaries based on any health factor
of such participants or beneficiaries.
These interim regulations interpret the
HIPAA nondiscrimination provisions.
Among other things, the interim regula-
tions -

· Explain the application of these
provisions to benefits;

· Clarify the relationship between
the HIPAA nondiscrimination
provisions and the HIPAA preex-
isting condition exclusion limita-
tions;

. Explain the application of these
provisions to premiums;

· Describe similarly situated indi-
viduals;

· Explain the application of these
provisions to actively-at-work
and nonconfinement clauses; and

· Clarify that more favorable treat-
ment of individuals with medical
needs generally is permitted.

Described in REG-114084-00 are pro-
posed standards for defining bona fide
wellness programs.

Of course, plans and benefits that are
not subject to the HIPAA portability pro-
visions (set forth in Chapter 100 of the
Code, Part 7 of Subtitle B of Title I of
ERISA, and Title XXVII of the PHS Act)
are not subject to the HIPAA nondiscrim-
ination requirements. Accordingly, the
following plans and benefits are not sub-
ject to the HIPAA nondiscrimination
requirements: benefits that qualify under
the HIPAA portability provisions as
excepted benefits; plans with fewer than
two participants who are current employ-
ees on the first day of the plan year3; and
self-funded non-Federal governmental

plans that elect, under 45 CFR 146.180, to
be exempt from these nondiscrimination
requirements. In addition, under a pro-
posed regulation published by the
Department of the Treasury and described
in REG-114083-00 on page 630 of this
Bulletin, certain church plans are treated
as not violating the general HIPAA
nondiscrimination provisions if the plan
requires evidence of good health for the
coverage of certain individuals.

### Health Factors

The HIPAA nondiscrimination provi-
sions set forth eight health status-related
factors. The interim regulations refer to
these as "health factors." The eight
health factors are health status, medical
condition (including both physical and
mental illnesses), claims experience,
receipt of health care, medical history,
genetic information, evidence of insura-
bility, and disability. These terms are
largely overlapping and, in combination,
include any factor related to an individ-
ual's health.

Evidence of insurability. Several com-
menters urged that the health factor "evi-
dence of insurability" be interpreted to
prohibit plans and issuers from denying
coverage to individuals who engage in
certain types of activities. Commenters
cited language in the conference report
that states, "The inclusion of evidence of
insurability in the definition of health sta-
tus is intended to ensure, among other
things, that individuals are not excluded
from health care coverage due to their
participation in activities such as motor-
cycling, snowmobiling, all-terrain vehicle
riding, horseback riding, skiing and other
similar activities." H.R. Conf. Rep. No.
736, 104th Cong., 2d Sess. 186 (1996).
The interim regulations clarify that evi-
dence of insurability includes participa-
tion in activities listed in the conference
report. In addition, the interim regula-
tions incorporate the statutory clarifica-
tion that evidence of insurability includes
conditions arising out of acts of domestic
violence. See also the discussion below
concerning source-of-injury restrictions

3 However, a State may impose the requirements of
the HIPAA portability provisions, in whole or in
part, on health insurance coverage sold to groups
that contain fewer than 2 current employees on the
first day of the plan year. See sections 2723 and
2791(e) of the PHS Act.

under the heading "Application to
Benefits."

Late enrollees and special enrollees.
Some commenters asked whether treating
late enrollees differently from other
enrollees is discrimination based on one
or more health factors. HIPAA was
designed to encourage individuals to
enroll in health coverage when first eligi-
ble and to maintain coverage for as long
as they continue to be eligible. Permitting
plans and issuers to treat late enrollees
less favorably than other enrollees is con-
sistent with this objective. The interim
regulations clarify that the decision
whether to elect health coverage, includ-
ing the time an individual chooses to
enroll, such as late enrollment, is not itself
within the scope of any health factor.
Thus, the interim regulations permit plans
and issuers to treat late enrollees differ-
ently from similarly situated individuals
who enroll when first eligible.

Although the HIPAA nondiscrimina-
tion requirements do not prohibit different
treatment of special enrollees, any differ-
ential treatment would violate the HIPAA
special enrollment requirements. These
interim regulations provide a cross-refer-
ence to the HIPAA regulations requiring
special enrollees to be treated the same as
individuals who enroll when first eligible.

Prohibited Discrimination in Rules for
Eligibility

These interim regulations provide that
group health plans and group health insur-
ance issuers generally may not establish
any rule for eligibility of any individual to
enroll for benefits under the terms of the
plan or group health insurance coverage
that discriminates based on any health
factor that relates to that individual or a
dependent of that individual. Under these
interim regulations, rules for eligibility
include, but are not limited to, rules relat-
ing to enrollment, the effective date of
coverage, waiting (or affiliation) periods,
late and special enrollment, eligibility for
benefit packages (including rules for indi-
viduals to change their selection among
benefit packages), benefits (as described
below under the heading "Application to
Benefits"), continued eligibility, and ter-
minating coverage of any individual
under the plan.

The rules for eligibility apply in tandem
with the rules describing similarly situat-

ed individuals (described below under the
heading "Similarly Situated Individuals")
to prevent discrimination in eligibility
based on any health factor. Thus, while it
is permissible for a plan or issuer to
impose waiting periods of different
lengths on different groups of similarly
situated individuals, a plan or issuer
would violate the interim regulations if it
imposed a longer waiting period for indi-
viduals within the same group of similar-
ly situated individuals based on the high-
er claims of those individuals (or based on
any other adverse health factor of those
individuals).

While the interim regulations clarify
that late enrollment itself is not within the
scope of any health factor, eligibility for
late enrollment comes within the scope of
rules for eligibility under which discrimi-
nation based on one or more health factors
is prohibited. The effect of these rules is
to permit plans or issuers to treat late
enrollees differently from individuals who
enroll when first eligible but to prohibit
plans and issuers from distinguishing
among applicants for late enrollment
based on any health factor of the appli-
cant. Thus, a plan could impose an 18-
month preexisting condition exclusion on
late enrollees while imposing no preexist-
ing condition exclusion on individuals
who enroll in the plan when first eligible,
but a plan would violate the interim regu-
lations if it conditioned the ability to
enroll as a late enrollee on the passing of
a physical examination (or on any other
health factor of the individual, such as
having incurred health claims during a
past period below a certain dollar
amount).

### Application to Benefits

General rules. The extent to which the
statutory language prohibits discrimina-
tion against individuals in eligibility for
particular benefits is subject to a wide
range of interpretations. At one extreme,
the language could be interpreted as
applying only to enrollment and to premi-
ums. Under this interpretation, for exam-
ple, it would be possible for a plan or
issuer to impose a $100 lifetime limit on a
particular individual with a history of high
health claims (provided that the individual
is permitted to enroll in the plan and is
charged the same premium as similarly
situated individuals), while imposing a $1

million lifetime limit on all other partici-
pants in the plan.

At the other extreme, the statutory lan-
guage could be interpreted to mandate
parity in health benefits. This interpreta-
tion would prevent plans and issuers from
designing benefit packages that control
costs and are responsive to employees'
preferences for balancing additional bene-
fits with additional costs.

In the preamble to the April 1997 inter-
im rules, the Departments specifically
invited comments on whether guidance
was needed concerning this issue. The
comments received ranged between these
two extremes. The approach in these
interim regulations takes into account the
concerns expressed by commenters, as
well as the conference report.
Specifically, the conference report states
that:

It is the intent of the conferees that a
plan cannot knowingly be designed to
exclude individuals and their depen-
dents on the basis of health status.
However, generally applicable terms of
the plan may have a disparate impact
on individual enrollees. For example, a
plan may exclude all coverage of a spe-
cific condition, or may include a life-
time cap on all benefits, or a lifetime
cap on specific benefits. Although indi-
viduals with the specific condition
would be adversely affected by an
exclusion of coverage for that condition
such plan characteristics would be
permitted as long as they are not direct-
ed at individual sick employees or
dependents.
.
.
.

H.R. Conf. Rep. No. 736, 104th Cong., 2d
Sess. 186 - 187 (1996).

The interim regulations clarify that they
do not require a plan or issuer to provide
coverage for any particular benefit to any
group of similarly situated individuals.
However, benefits provided under a plan
or group health insurance coverage must
be uniformly available to all similarly sit-
uated individuals. Likewise, any restric-
tion on a benefit or benefits must apply
uniformly to all similarly situated individ-
uals and must not be directed at individual
participants or beneficiaries based on any
health factor of the participants or benefi-
ciaries (determined based on all the rele-
vant facts and circumstances). Thus, for
example, a plan or issuer may limit or
exclude benefits in relation to a specific

disease or condition, limit or exclude ben-
efits for certain types of treatments or
drugs, or limit or exclude benefits based
on a determination of whether the benefits
are experimental or not medically neces-
sary, but only if the benefit limitation or
exclusion applies uniformly to all similar-
ly situated individuals and is not directed
at individual participants or beneficiaries
based on any health factor of the partici-
pants or beneficiaries. In addition, a plan
or issuer may impose annual, lifetime, or
other limits on benefits and may require
the satisfaction of a deductible, copay-
ment, coinsurance, or other cost-sharing
requirement in order to obtain a benefit if
the limit or cost-sharing requirement
applies uniformly to all similarly situated
individuals and is not directed at individ-
ual participants or beneficiaries based on
any health factor of the participants or
beneficiaries.4 These interim regulations
clarify that whether any plan provision
with respect to benefits complies with the
interim regulations does not affect
whether the provision is permitted under
the Americans with Disabilities Act
(ADA), or any other law, whether State or
federal.5

Accordingly, for example, a group
health plan may apply a lifetime limit on
all benefits provided to each participant
covered under the plan. While this limita-
tion on all benefits may adversely impact
individuals with serious medical condi-
tions, the limitation is permitted provided
that it applies to all similarly situated indi-
viduals and is not directed at individual
participants or beneficiaries. Similarly, a
plan or issuer may establish a specific
lifetime limit on the treatment of a partic-
ular condition (such as the treatment of
temporomandibular joint syndrome
(TMJ)) for all similarly situated individu-
als in the plan. Although individuals with
TMJ may be adversely affected by this
limitation, because benefits for the treat-

ment of TMJ are available uniformly to all
similarly situated individuals and because
the limit on benefits for TMJ applies to all
similarly situated individuals, the limit is
permissible.

Under these interim regulations, plans
and issuers therefore have significant
flexibility in designing benefits.
However, to prevent plans and issuers
from restricting benefits based on a spe-
cific health factor of an individual under
the plan, the interim regulations prohibit
benefit restrictions, even if applied uni-
formly to all similarly situated individu-
als, from being directed at individual par-
ticipants or beneficiaries based on any
health factor of the participants or benefi-
ciaries. The interim regulations clarify
that a plan amendment applicable to all
individuals in one or more groups of sim-
ilarly situated individuals under the plan
and made effective no earlier than the first
day of the first plan year after the amend-
ment is adopted is not considered to be
directed at individual participants and
beneficiaries. This exception to the gener-
al facts and circumstances determination
that a change is directed at an individual is
necessary to preserve the flexibility of
small employers that might otherwise be
disproportionately affected and prevented
from adopting changes in benefit design.
If small employers are unable to modify
future benefits to keep health coverage
affordable, their alternative may be to
eliminate health coverage entirely. At the
same time, the exception reflects the com-
mon practice of modifying the terms of a
plan on an annual basis. Finally, changes
in benefit design that are effective earlier
than the first day of the next plan year
remain subject to a facts and circum-
stances determination regarding whether
the change is directed at individual partic-
ipants and beneficiaries.

An example illustrates that if an individ-
ual files a claim for the treatment of a con-
dition, and shortly thereafter the plan is
modified to restrict benefits for the treat-
ment of the condition, effective before the
beginning of the next plan year, the restric-
tion would be directed at the individual
based on a health factor (absent additional
facts to indicate that the change was made
independent of the claim) and the plan
would violate these interim regulations.

Source-of-injury restrictions. While a
person cannot be excluded from a plan for

engaging in certain recreational activities
(see previous discussion on evidence of
insurability under the heading "Health
Factors"), benefits for a particular injury
can, in some cases, be excluded based on
the source of an injury. These plan
restrictions are known as source-of-injury
restrictions.6 Under these interim regula-
tions, if a plan or group health insurance
coverage generally provides benefits for a
type of injury, the plan or issuer may not
use a source-of-injury restriction to deny
benefits otherwise provided for treatment
of the injury if it results from an act of
domestic violence or a medical condition
(including both physical and mental
health conditions). An example in the
interim regulations clarifies that benefits
for injuries generally covered under the
plan cannot be excluded merely because
they were self-inflicted or were sustained
in connection with a suicide or attempted
suicide if the injuries resulted from a med-
ical condition such as depression.
Another example illustrates that a plan
can nonetheless exclude benefits for
injuries because they were sustained in
connection with various recreational
activities if the accident did not result
from any medical condition (or from
domestic violence).

### The Relationship Between the HIPAA Nondiscrimination Provisions and the HIPAA Preexisting Condition Exclusion Provisions

Restrictions on benefits based on the
fact that a medical condition was present
before the first day of coverage discrimi-
nate against individuals based on one or
more health factors. The statute nonethe-
less provides that the nondiscrimination
provisions are intended to be construed in
a manner consistent with the HIPAA pro-
visions specifically allowing the applica-
tion of preexisting condition exclusions.
These latter provisions restrict the ability
of a group health plan or group health
insurance issuer to apply preexisting con-
dition exclusions, both by restricting the

4 For special rules that apply to cost-sharing mech-
anisms that are part of a bona fide wellness pro-
gram, see the proposed regulations relating to bona
fide wellness programs published elsewhere in this
issue of the Bulletin.

5 In this regard, the Equal Employment Opportunity
Commission has commented, by letter of July 7,
1997, "Title I of the ADA prohibits disability-based
employment discrimination, including discrimina-
tion in fringe benefits such as health insurance
plans."

6 A commenter pointed out that this type of restric-
tion is distinct from two other restrictions sometimes
referred to as "source-of-injury restrictions" - (1)
those based on the geographic location where the
injury occurred, and (2) those based on when the
injury occurred and whether other coverage was in
effect.

circumstances under which an individ-
ual's condition is considered preexisting
and by limiting the length of the exclusion
period. The interim regulations clarify
that a preexisting condition exclusion that
satisfies the requirements of the HIPAA
preexisting condition exclusion provi-
sions is permitted under the HIPAA
nondiscrimination requirements if the
exclusion applies uniformly to individuals
within the same group of similarly situat-
ed individuals and is not directed at indi-
vidual participants or beneficiaries based
on any health factor of the participants or
beneficiaries. A plan amendment relating
to a preexisting condition exclusion
applicable to all individuals in one or
more groups of similarly situated individ-
uals under the plan and made effective no
earlier than the first day of the first plan
year after the amendment is adopted is not
considered to be directed at individual
participants or beneficiaries.

The examples illustrate that a typical
preexisting condition exclusion permitted
under the HIPAA preexisting condition
exclusion requirements does not violate
the HIPAA nondiscrimination require-
ments even though the exclusion inherent-
ly discriminates based on one or more
health factors. The examples also illus-
trate that a plan nonetheless must apply
the preexisting condition exclusion to
similarly situated individuals in a uniform
manner and cannot apply a longer preex-
isting condition exclusion period based on
the submission of claims during the first
part of the exclusion period.

Prohibited Discrimination in Premiums
or Contributions

Under the interim regulations, a group
health plan, and a health insurance issuer
offering health insurance coverage in con-
nection with a group health plan, may not
require an individual, as a condition of
enrollment or continued enrollment under
the plan or group health insurance cover-
age, to pay a premium or contribution that
is greater than the premium or contribu-
tion for a similarly situated individual
enrolled in the plan or group health insur-
ance coverage, based on any health factor
that relates to that individual or a depen-
dent of that individual. Under the interim
regulations, when determining an individ-
ual's premium or contribution rate, dis-

counts, rebates, payments in kind, or other
premium differential mechanisms are
taken into account.7

In general, the interim regulations do
not restrict the amount that an employer
may be quoted or charged by an issuer (or,
in the case of a multiemployer plan, by the
plan) for coverage of a group of similarly
situated individuals. However, the inter-
im regulations prohibit certain billing
practices because in many instances they
could directly or indirectly result in an
individual's being charged more than a
similarly situated individual based on a
health factor.

Some health insurance issuers that offer
health insurance coverage in connection
with a group health plan use billing prac-
tices with separate individual rates that
vary based, in part, on the health factors
of the individuals who are eligible to par-
ticipate in the plan. This practice is gen-
erally known as list billing. List billing
based on a health factor is prohibited
under the interim regulations.

The HIPAA nondiscrimination require-
ments do not prohibit an issuer from con-
sidering all relevant health factors of indi-
viduals in order to establish aggregate
rates for coverage provided under the
group health plan. However, an individ-
ual may not be required to pay a higher
premium based on any health factor of the
individual. Under the interim regulations,
an issuer (or a multiemployer plan) may
not quote or charge an employer different
premium rates on an individual-by-indi-
vidual basis in a group of similarly situat-
ed individuals based on any health factor
of the individuals, even if the employer
does not pass the different rates through to
the individuals. If an issuer wishes to
increase rates to cover the additional
exposure to expenses that may result from
an individual's health factor, the issuer
must blend the increase into an overall
group rate and then quote or charge a
higher per-participant rate. Nonetheless,
the prohibition on the practice of list
billing based on a health factor does not

7 However, a group health plan or a health insurance
issuer offering group health insurance coverage may
establish premium or contribution differentials
through a bona fide wellness program. (See pro-
posed regulations relating to bona fide wellness pro-
grams published elsewhere in this issue of the
Bulletin.)

restrict communications between issuers
and plans regarding rate calculations.

### Similarly Situated Individuals

The statutory HIPAA nondiscrimina-
tion requirements clarify that the general
rule prohibiting discrimination in eligibil-
ity does not prevent a group health plan or
group health insurance coverage from
establishing limitations or restrictions on
the amount, level, extent, or nature of ben-
efits for "similarly situated individuals"
enrolled in the plan or coverage. The
statutory rule prohibiting discrimination
in charging individuals premiums or con-
tributions prohibits a plan or issuer from
requiring any individual, based on any
health factor of that individual or a depen-
dent of that individual, to pay a premium
or contribution that is greater than the pre-
mium or contribution required of a "simi-
larly situated individual." In the preamble
to the April 1997 interim rules, the
Departments requested comments both on
the permissible standards for defining
groups of similarly situated individuals
and on the application of the prohibitions
on discrimination between groups of sim-
ilarly situated individuals.

Many commenters suggested that dis-
crimination between groups of similarly
situated individuals should be permitted,
with the caveat that it should not be per-
missible to define a group based on a
health factor. These interim regulations
provide that the nondiscrimination rules
apply only within a group of similarly sit-
uated individuals. Thus, these interim
regulations do not prohibit discrimination
between or among groups of similarly sit-
uated individuals. However, these interim
regulations also provide that if the cre-
ation or modification of an employment
or coverage classification is directed at
individual participants or beneficiaries
based on any health factor of the partici-
pants or beneficiaries, the classification is
not permitted. This is intended to be a
broad anti-abuse standard that applies
based on the relevant facts and circum-
stances of each case.

The permissibility of discrimination
between or among groups of similarly sit-
uated individuals increases the possibility
of abuse in establishing groups of similar-
ly situated individuals. Most commenters
addressing this issue focused on the clas-

sification of participants and suggested
that classifications should be based on
work activities and not on a health factor
or on activities unrelated to employment.
The interim regulations provide generally
that participants may be treated as two or
more groups of similarly situated individ-
uals if the distinction between or among
the groups is based on a bona fide
employment-based classification consis-
tent with the employer's usual business
practice. The validity of a category as a
bona fide employment-based classifica-
tion is determined based on all the rele-
vant facts and circumstances. Relevant
facts and circumstances include whether
the employer uses the classification for
purposes independent of qualification for
health coverage (for example, determin-
ing eligibility for other employee benefits
or determining other terms of employ-
ment). Subject to the anti-abuse standard
(described in the preceding paragraph),
the interim regulations allow distinctions
to be made based on full-time versus part-
time status, different geographic location,
membership in a collective bargaining
unit, date of hire, length of service, cur-
rent employee versus former employee
status, and different occupations.

Some commenters expressed concern
that allowing similarly situated individu-
als to be determined based on occupation
or geographic location would allow plans
and issuers to create artificial classifica-
tions, ostensibly based on occupation or
geographic location, that are actually
designed to discriminate based on a health
factor of an individual or individuals.
These interim regulations permit bona
fide classifications based on occupation or
geographic location. In this connection,
commenters had two principal concerns.
First, there was a concern about reclassifi-
cations targeting unhealthy individuals.
For example, a participant receiving
expensive medical treatment might be
reclassified to a separate employment cat-
egory either with reduced health benefits
or none at all. The broad anti-abuse stan-
dard of these interim regulations is intend-
ed, among other things, to prohibit reclas-
sifications directed at individuals such as
this.

A second concern that commenters had
was that plans and issuers might design
health benefits differently for employees
in different occupations or geographic

locations based, at least in part, on the
health factors of these groups of individu-
als. One example is a plan that offers
fewer benefits to employees in one occu-
pation than to employees in another occu-
pation at least in part because of the high-
er average historical claims of the
employees in the first occupation. A sec-
ond example is a plan that charges
employees in one area more than employ-
ees in another area at least in part because
the cost of medical care is generally high-
er in the first area. The statute and leg-
islative history appear to allow this prac-
tice, and thus these interim regulations do
not prohibit the provision of different
health benefits for employees in different
occupations or geographic locations,
based at least in part on the health factors
of the group as a whole, if the classifica-
tions are not directed at individual partic-
ipants or beneficiaries based on a health
factor of the participants or beneficiaries.

These interim regulations also permit
plans and issuers, in certain circumstances,
to treat beneficiaries as different groups of
similarly situated individuals.
Beneficiaries may be treated as a group of
similarly situated individuals separate
from participants, and different treatment
is permitted among beneficiaries based on
bona fide employment-based classifica-
tions of the participants through whom the
beneficiaries are receiving coverage.
Thus, if the plan provides different bene-
fits to full-time employees than to part-
time employees, then it may also provide
different benefits to dependents of full-
time employees than to dependents of
part-time employees. Similarly, different
treatment is permitted based on the benefi-
ciary's relationship to the participant (for
example, as a spouse or as a dependent
child). Different treatment is also permit-
ted based on the beneficiary's marital sta-
tus, based on a dependent child's age or
student status, or based on any other factor
if the factor is not a health factor.

The rules in these interim regulations
allowing the different treatment of indi-
viduals in different groups of similarly sit-
uated individuals are distinct from rules
requiring that qualified beneficiaries
under a COBRA continuation provision8

8 The term COBRA continuation provision is defined
in 26 CFR 54.9801-2T, 29 CFR 2590.701-2, and 45
CFR 144.103.

have available the same coverage as simi-
larly situated non-COBRA beneficiaries.
Although these interim regulations would
not prohibit making benefit packages
available to non-COBRA beneficiaries
(such as current employees) that are not
made available to COBRA qualified ben-
eficiaries (such as former employees), the
COBRA continuation provisions prohibit
such a difference.

Finally, all of the requirements relating
to determining groups of similarly situat-
ed individuals are subject to other rules in
these interim regulations permitting
favorable treatment of individuals with
certain adverse health factors (discussed
below under the heading "More Favorable
Treatment of Individuals with Adverse
Health Factors Permitted").

### Nonconfinement Provisions

Some group health plans and health
insurance issuers refuse to provide bene-
fits to an individual based on the individ-
ual's confinement to a hospital or other
health care institution at the time coverage
otherwise would become effective. Plan
provisions like these are often called
"nonconfinement clauses." Any reason-
able interpretation or application of the
statutory HIPAA nondiscrimination provi-
sions prohibits a plan or issuer from
imposing a nonconfinement clause.9
Thus, a plan or issuer may not deny the
eligibility of any individual to enroll for
benefits or charge any individual a higher
premium (or contribution) because the
individual, or a dependent of the individ-
ual, is confined to a hospital or other
health care institution. In addition, some
plans and issuers refuse to provide bene-
fits to an individual based on an individ-
ual's inability to engage in normal life
activities. A plan or issuer generally may
not deny the eligibility of any individual
to enroll for benefits or charge any indi-
vidual a higher premium (or contribution)
based on any individual's ability to
engage in normal life activities. However,

9 For an example illustrating that the imposition of
a nonconfinement clause is not a good faith inter-
pretation of the HIPAA nondiscrimination provi-
sions, and the rule requiring that individuals denied
enrollment without a good faith interpretation of the
law be provided an opportunity to enroll, see the
discussion below under the heading "Transitional
Rule for Individuals Previously Denied Coverage
Based on a Health Factor."

these interim regulations provide an
exception that permits plans and issuers to
distinguish among employees based on
the performance of services. Although in
practice nonconfinement clauses general-
ly apply only to dependents, in some cases
they apply also to employees. Thus, the
interim regulations clarify that a noncon-
finement clause would also be impermis-
sible if applied to an employee.

These rules are of particular interest in
the case of a group health plan switching
coverage from one health insurance issuer
to a succeeding health insurance issuer. In
such a case, the HIPAA nondiscrimination
provisions prohibit the succeeding issuer
from denying eligibility to any individual
due to confinement to a hospital or other
health care institution because such a
denial would discriminate in eligibility
based on one or more health factors. The
obligation of the succeeding issuer to pro-
vide coverage to such an individual does
not preempt any obligation that the prior
issuer may have under other applicable
law, including State extension of benefits
laws.

### Actively-At-Work and Other Service Requirements

Some group health plans and health
insurance issuers refuse to provide bene-
fits to an individual if the individual is not
actively at work on the day the individual
would otherwise become eligible for ben-
efits. Plan provisions like these are often
called "actively-at-work clauses." These
interim regulations provide that a plan or
issuer generally may not impose an
"actively-at-work clause." That is, these
interim regulations prohibit a plan or
issuer from denying the eligibility of any
individual to enroll for benefits or charg-
ing any individual a higher premium or
contribution based on whether an individ-
ual is actively at work (including whether
an individual is continuously employed).
However, an actively-at-work clause is
permitted if individuals who are absent
from work due to any health factor (for
example, individuals taking sick leave)
are treated, for purposes of health cover-
age, as if they are actively at work.
Accordingly, plan provisions that delay
enrollment until an individual is actively
at work on a day following a waiting peri-
od (or for a continuous period) are pro-
hibited unless absence from work due to

any health factor is considered being
actively at work.

These interim regulations also provide
an exception for the first day of work to
the general prohibition against actively-
at-work clauses. Under the exception, a
plan or issuer may require an individual to
begin work before coverage may become
effective.

The interim regulations explain the
relationship between the rules governing
actively-at-work clauses and the rules
describing similarly situated individuals.
Under the interim regulations, a plan or
issuer is generally permitted to distinguish
between groups of similarly situated indi-
viduals (provided the distinction is not
directed at individual participants or ben-
eficiaries based on a health factor).
Examples illustrate that a plan or issuer
may condition coverage on an individ-
ual's meeting the plan's requirement of
working full-time (such as a minimum of
250 hours in a three-month period or 30
hours per week). In addition, a plan or
issuer may terminate coverage for former
employees while providing coverage to
current employees without violating the
HIPAA nondiscrimination provisions if
the rules describing similarly situated
individuals are satisfied, even if the for-
mer employee is unable to work due to a
health factor. Similarly, a plan or issuer
may charge a higher premium to employ-
ees no longer performing services than to
employees currently performing services
without violating the HIPAA nondiscrim-
ination provisions if the rules describing
similarly situated individuals are met. An
example illustrates that the interim regula-
tions would not, however, permit a plan or
issuer to treat individuals on annual or
bereavement leave better than individuals
on sick leave because groups of similarly
situated individuals cannot be established
based on any health factor (including the
taking of sick leave).

In any case, other federal or State laws,
including the COBRA continuation provi-
sions and the Family and Medical Leave
Act of 1993 (FMLA), may require indi-
viduals to be offered coverage and set lim-
its on the premium or contribution rate.

Bona Fide Wellness Programs

The HIPAA nondiscrimination provi-
sions do not prevent a plan or issuer from
establishing premium discounts or rebates

or modifying otherwise applicable copay-
ments or deductibles in return for adher-
ence to programs of health promotion and
disease prevention. Thus, there is an
exception to the general rule prohibiting
discrimination based on a health factor if
the reward, such as a premium discount or
waiver of a cost-sharing requirement, is
based on participation in a program of
health promotion or disease prevention.
The April 1997 interim rules, these inter-
im regulations, and proposed regulations
published elsewhere in this issue of the
Bulletin refer to programs of health pro-
motion and disease prevention allowed
under this exception as "bona fide well-
ness programs." For a discussion of bona
fide wellness programs, see the preamble
to proposed regulations published else-
where in this issue of the Bulletin.

### More Favorable Treatment of Individuals with Adverse Health Factors Permitted

Many group health plans make certain
periods of extended coverage available
to employees no longer performing ser-
vices only if the employee is unable to
work due to disability, and many plans
make coverage available to dependent
children past a certain age only if the
child is disabled. Some plans waive or
reduce the required employee contribu-
tion for coverage if the employee or a
member of the employee's immediate
family is in a critical medical condition
for a prolonged period. Disability and
medical condition are listed in the statute
as health factors, and several com-
menters recognized that, under one pos-
sible interpretation of the HIPAA nondis-
crimination requirements, plan
provisions or practices such as these
would be impermissible. These com-
menters asked for guidance clarifying
that plan provisions and practices like
these would be permissible. Other com-
menters cited the rule under the COBRA
continuation provisions permitting plans
to require payment of a higher amount
during the disability extension than dur-
ing other periods of COBRA coverage
and asked whether following this
COBRA rule is permissible under the
HIPAA nondiscrimination requirements.

Eligibility. These interim regulations
permit plans and issuers to establish rules
for eligibility favoring individuals based
on an adverse health factor, such as dis-

ability. Thus, a plan or issuer does not
violate the HIPAA nondiscrimination
requirements by making extended cover-
age available to employees no longer pro-
viding services only if the employee is
unable to work due to disability nor by
making coverage available to dependent
children past a certain age only if the child
is disabled. Examples clarify this rule.

Premiums. These interim regulations
also address the circumstances under
which differential premiums (or contribu-
tions) may be charged to an individual
based on an adverse health factor. These
interim regulations permit plans and
issuers to charge a higher rate in some sit-
uations and also a lower rate to individu-
als based on an adverse health factor, such
as disability. A higher rate may be
charged only in situations where the indi-
vidual with the adverse health factor
would not have coverage were it not for
the adverse health factor. Thus, in a case
where a plan or issuer makes extended
coverage available to employees no
longer performing services only if the
employee is unable to work due to dis-
ability, the plan could require a higher
payment from the employee only while
the employee is receiving coverage under
that special eligibility provision.
However, the plan could not charge a dis-
abled employee a higher rate than nondis-
abled employees while the disabled
employee was still eligible under a gener-
ally-applicable eligibility provision,
rather than the special extended coverage
provision. Accordingly, under the interim
regulations, a plan or issuer could charge
a higher rate for COBRA coverage during
the disability extension than for COBRA
coverage outside the disability extension
(and the result is the same if the extended
coverage for disability is provided pur-
suant to State law or plan provision rather
than pursuant to a COBRA continuation
provision). 10

Although charging a higher rate based
on an adverse health factor is limited to
the situation in which coverage would not
be available but for the adverse health fac-

tor, under these interim regulations a plan
or issuer is always permitted to charge an
individual a lower rate based on an
adverse health factor. Thus, even though
an employee is receiving coverage under
the same eligibility provision as other
employees who are required to pay the
full employee share of the premium,
under the interim regulations it is permis-
sible to waive or reduce the employee
share of the premium if the employee or a
family member is in critical medical con-
dition for a prolonged period.

### No Effect on Other Laws

Compliance with these interim regula-
tions is not determinative of compliance
with any other provision of ERISA, or any
other State or federal law, including the
Americans with Disabilities Act.
Therefore, while these interim regulations
generally do not impose any new disclo-
sure requirements on plans or issuers,
other applicable law continues to apply.
For example, under Title I of ERISA,
administrators of ERISA-covered group
health plans are required to provide par-
ticipants and beneficiaries with a summa-
ry plan description that is sufficiently
accurate and comprehensive to reasonably
apprise such participants and beneficiaries
of their rights and obligations under the
plan.11 In addition, some courts have held
that fiduciaries of ERISA-covered group
health plans are obligated to ensure that
plan documents and disclosures are con-
sistent with applicable disclosure require-
ments and do not serve to mislead or mis-
inform participants and beneficiaries
concerning their rights and obligations
under the plans in which they partici-
pate.12 Fiduciaries are advised to take
steps to ensure that plan disclosures are
accurate and are not misleading.

These interim regulations are also not
determinative of compliance with the
COBRA continuation provisions, or any
other State or federal law, such as the
Americans with Disabilities Act.

Applicability Date

These interim regulations generally
apply for plan years beginning on or after

11 See ERISA section 102, and the Department of
Labor's regulations issued thereunder.

12 See Varity Corp v. Howe, 516 U.S. 489, 506
(1996).

July 1, 2001 (although some provisions
apply earlier, as discussed below under
the heading "III. Format of Regulations").
As noted above, in the preamble to the
April 1997 interim rules the Departments
stated that they intended to issue further
regulations on the statutory nondiscrimi-
nation rules. That preamble also stated
that in no event would the Departments
take any enforcement action against a
plan or issuer that had sought to comply in
good faith with the statutory nondiscrimi-
nation provisions before the additional
guidance was issued. The Departments
will not take any enforcement action
against a plan or issuer with respect to
efforts to comply in good faith with the
statutory nondiscrimination provisions
before the first plan year beginning on or
after July 1, 2001. (See the description of
transitional rules immediately below
regarding certain interpretations that are
not good faith interpretations of the statu-
tory nondiscrimination requirements.)
Upon the applicability of these regula-
tions, however, good faith efforts to com-
ply with the statutory provisions
addressed by these interim regulations
may not be sufficient to avoid adverse
enforcement actions by the Departments.
Therefore, for plan years beginning on or
after July 1, 2001, plans and issuers must
comply with the requirements of these
regulations in order to avoid adverse
enforcement actions. As discussed earlier,
under the heading "Background," the
period for good faith compliance contin-
ues with respect to bona fide wellness
programs until further guidance is issued.

Transitional Rules for Individuals
Previously Denied Coverage Based on a
Health Factor

The April 1997 interim rules clarified
that a plan or issuer violates the HIPAA
nondiscrimination requirements if it
requires an individual to pass a physical
examination as a condition for enroll-
ment, even if the condition is imposed
only on late enrollees. The HIPAA
nondiscrimination requirements apply
both to eligibility and continued eligibili-
ty of any individual to enroll under a plan.
Consequently, once HIPAA became effec-
tive with respect to a plan or health insur-
ance issuer, it was a violation of the
nondiscrimination requirements to contin-
ue to deny an individual eligibility to

10 This result is consistent with the result under the
COBRA continuation provisions. Under those pro-
visions, plans are generally permitted to require
payment of up to 102 percent of the applicable pre-
mium but are permitted to require payment for cov-
erage of a disabled qualified beneficiary of up to
150 percent of the applicable premium during the
disability extension period.

enroll if the reason the individual was
denied enrollment previously was due to
one or more health factors (such as requir-
ing the individual to pass a physical
examination).

On December 29, 1997, the Departments
issued in the Federal Register a clarifica-
tion of the April 1997 interim rules relating
to individuals who were denied coverage
due to a health factor before the effective
date of HIPAA (62 F.R. 67689). The clari-
fication restates the requirement of the
April 1997 interim rules that an individual
cannot be denied coverage based on a
health factor on or after the effective date of
HIPAA. The clarification then states that
individuals to whom coverage had not been
made available before the effective date of
HIPAA based on a health factor and who
enrolled when first eligible on or after the
effective date of the HIPAA nondiscrimina-
tion provisions could not be treated as a late
enrollee for purposes of the HIPAA preex-
isting condition exclusion provisions.
Under the clarification, individuals to
whom coverage had not been made avail-
able include any individual who did not
apply for coverage because it was reason-
able to believe that the application would
have been futile. The rules in the clarifica-
tion apply whether or not the plan offered
late enrollment.

Neither the April 1997 interim rules nor
the December 1997 guidance clearly
addressed the situation where an individ-
ual was denied only late enrollment based
on a health factor prior to the effective
date of HIPAA and, by the effective date
of HIPAA, the plan eliminated late enroll-
ment. For example, prior to HIPAA many
plans and issuers allowed individuals to
enroll when first eligible without regard to
health status, but allowed late enrollees to
enroll only if they could pass a physical
examination (or present evidence of good
health). Upon the effective date of
HIPAA, some of these plans and issuers
eliminated late enrollment.

Any plan or issuer that permitted these
individuals to enroll once the HIPAA
nondiscrimination provisions took effect,
of course, is in compliance with this pro-
vision of the nondiscrimination rules. In
contrast, a plan or issuer that continued to
deny coverage to these individuals may
have done so based on a good faith inter-
pretation of the statute and the

Departments' published guidance. For
example, a plan or issuer might reason-
ably have thought that HIPAA did not
require it to remedy pre-HIPAA denials of
late enrollment based on a health factor
for individuals who could have enrolled
initially without regard to their health if
the plan or issuer eliminated late enroll-
ment by the effective date of HIPAA.

The interim regulations provide transi-
tional rules for situations where coverage
was denied to individuals based on one or
more health factors, both where the denial
was based on a good faith interpretation
of the statute or the Departments' pub-
lished guidance and where it was not. In
either event, a safe harbor provides that
the Departments will not take any
enforcement action with respect to such a
denial of coverage if the plan or issuer
complies with the transitional rules.

Where the denial was not based on a
good faith interpretation, the interim reg-
ulations provide that the plan or issuer is
required to give the individual an oppor-
tunity to enroll (including notice of an
opportunity to enroll) that continues for at
least 30 days. This opportunity must be
presented not later than March 9, 2001. If
the opportunity is presented within the
first plan year beginning on or after the
effective date of the statutory HIPAA
nondiscrimination rules, the enrollment
must be effective within that plan year. If
this enrollment opportunity is presented
after such plan year, the individual must
be given an option to have coverage effec-
tive either (1) prospectively from the date
the plan receives a request for enrollment
in connection with the enrollment oppor-
tunity or (2) retroactively to the first day
of the first plan year beginning on
HIPAA's effective date for the plan (or, if
the individual otherwise first became eli-
gible to enroll for coverage after that date,
on the date the individual was otherwise
eligible to enroll in the plan).

The reason for giving the individual the
opportunity to elect retroactive coverage
is to make the individual whole; that is, to
put the individual in the same financial
condition that the individual would have
been in had the individual not been denied
enrollment. Thus, if the individual elects
retroactive coverage, the plan or issuer
may require the individual to pay premi-
ums or contributions for the retroactive

period (but the plan or issuer cannot
charge interest on that amount).

The rule differs for situations where cov-
erage was denied to individuals based on
one or more health factors but where the
denial was based on a good faith interpre-
tation of the statute or the Departments'
prior published guidance. In those situa-
tions, these interim regulations require
plans and issuers to give the individuals an
opportunity to enroll that continues for at
least 30 days and with coverage effective
not later than July 1, 2001.

In both situations (whether the denial of
coverage was or was not based on a good
faith interpretation), the interim regulations
also clarify that, once enrolled, these indi-
viduals cannot be treated as late enrollees.
The individual's enrollment date under the
plan is the effective date of HIPAA (or, if
later, the date the individual would have
otherwise been eligible to enroll). In addi-
tion, any period between an individual's
enrollment date and the effective date of
coverage is treated as a waiting period.
Thus, for example, with respect to a calen-
dar year plan that is not collectively bar-
gained, an individual who was previously
denied late enrollment due to a health factor
before the effective date of HIPAA has an
enrollment date of January 1, 1998
(HIPAA's effective date for that plan) and a
waiting period that begins on that date.
Moreover, because any waiting period must
begin on the individual's enrollment date,
January 1, 1998, and the maximum preex-
isting exclusion period that can be applied
is 12 months, individuals who enroll in the
plan on July 1, 2001 cannot be subject to
any preexisting condition exclusion period.

Special Transitional Rule for Self-Funded
Non-Federal Governmental Plans
Exempted under 45 CFR 146.180

The sponsor of a self-funded non-
Federal governmental plan may elect
under section 2721(b)(2) of the PHS Act
and 45 CFR 146.180 to exempt its group
health plan from the nondiscrimination
requirements of section 2702 of the PHS
Act and 45 CFR 146.121. If the plan
sponsor subsequently chooses to bring the
plan into compliance with these nondis-
crimination requirements, the plan must
provide notice to that effect to individuals
who were denied enrollment based on one
or more health factors, and afford those

individuals an opportunity, that continues
for at least 30 days, to enroll in the plan.
(An individual is considered to have been
denied coverage if he or she failed to
apply for coverage because, given an
exemption election under 45 CFR
146.180, it was reasonable to believe that
an application for coverage would have
been denied based on a health factor.)
The notice must specify the effective date
of compliance, and inform the individual
regarding any enrollment restrictions that
may apply under the terms of the plan
once the plan comes into compliance.
The plan may not treat the individual as a
late enrollee or a special enrollee.
Coverage must be effective no later than
the date the exemption election under 45
CFR 146.180 (with regard to these
nondiscrimination requirements) no

longer applies, or July 1, 2001 (if later)
and the plan was acting in accordance
with a good faith interpretation of the
statutory HIPAA nondiscrimination provi-
sions and guidance published by the
Health Care Financing Administration.

## III. Format of Regulations

### Final and Temporary Treasury Regulations

The Department of the Treasury is issu-
ing a portion of these regulations as final
regulations and a portion as temporary
and cross-referencing proposed regula-
tions. The April 1997 interim rules were
originally issued by Treasury in the form
of temporary and cross-referencing pro-
posed regulations. Under section
7805(e)(2) of the Code, however, any

temporary regulation issued under the
Code expires within three years after the
date issued. Treasury is issuing final reg-
ulations that restate the rules relating to
the HIPAA nondiscrimination require-
ments from the April 1997 regulations
without significant modification. The
final regulations apply March 9, 2001.
Table 1 identifies which paragraphs of the
final regulation issued today correspond
to which paragraphs of the April 1997
regulation. New guidance being pub-
lished today by Treasury is being issued
as temporary and cross-referencing pro-
posed regulations. This guidance will
apply to group health plans beginning
with the first plan year on or after July 1,
2001. (These new temporary regulations
will also expire after three years pursuant
to section 7805(e) of the Code.)

Table 1 Comparison of Treasury's April 1997 Regulations with Treasury's Final Regulations

April 1997 Regulations

Final Regulation under §9802

§54.9802-1T(a)(1)

§54.9802-1(a)(1),(2); (b)(1)

§54.9802-1T(a)(2)(i)

§54.9802-1(b)(2)(i)(A)

§54.9802-1T(a)(3)

[The corresponding provision is in the new temporary regulations.]

§54.9802-1T(a)(4)

§54.9802-1(b)(1)(iii)

§54.9802-1T(b)(1)

§54.9802-1(c)(1)(i)

§54.9802-1T(b)(2)(i)

§54.9802-1(c)(2)(i)

§54.9802-1T(b)(2)(ii)

§54.9802-1(b)(2)(i); (c)(3)

§54.9802-1T(b)(3)

[The corresponding provision is in the new proposed regulations for wellness programs.]

Interim Final Labor and HHS
Regulations

The guidance issued by the
Departments of Labor (Labor) and Health
and Human Services (HHS) in April 1997

is not subject to a statutory expiration
date. Accordingly, the Labor and HHS
guidance is being published as interim
final regulations. These regulations con-
tain two applicability dates that parallel
the two separate applicability dates in the

Treasury guidance. Table 2 identifies
which paragraphs of the interim final reg-
ulation issued today are applicable on
March 9, 20001 and which paragraphs
take effect on or after July 1, 2001.

Table 2 Applicability Dates for the Interim Final Regulations

Subject

Paragraph of the Interim Final Regulations

Applies March 9, 2001

Applies plan years beginning on or after 7/1/2001

Health factors

(a)(1)

☒ ✓

Health factors - Evidence of insurability - Conditions arising out of an act of domestic violence

(a)(2)(i)

☒ ✓

Subject

Paragraph of the Interim Final Regulations

Applies March 9, 2001

Applies plan years beginning on or after 7/1/2001

Health factors - Evidence of insurability - Participation in certain activities

(a)(2)(ii)

✓ ☒

Health factors - The decision whether health coverage is elected

(a)(3)

☒ ✓

Prohibited discrimination in rules for eligibility - General rule

(b)(1)(i)

☒ ✓

Prohibited discrimination in rules for eligibility - Rules for eligibility described

(b)(1)(ii)

☒ ✓

Prohibited discrimination in eligibility - General rule - Example 1

(b)(1)(iii) Example 1

☒ ✓

Prohibited discrimination in eligibility - General rule - Examples 2 through 4

(b)(1)(iii) Examples 2 through 4

☒ ✓

Prohibited discrimination in eligibility - Application to benefits - No benefits mandated

(b)(2)(i)(A)

☒ ✓

Prohibited discrimination in eligibility - Application to benefits - Nondiscrimi- natory benefit restrictions permitted

(b)(2)(i)(B), (C), &amp; (D)

☒ ✓

Prohibited discrimination in eligibility - Application to benefits - Certain cost-sharing mechanisms

(b)(2)(ii)

☒ ✓

Prohibited discrimination in eligibility - Application to benefits - Source-of-injury exclusions

(b)(2)(iii)

☒ ✓

Prohibited discrimination in eligibility - Application to benefits - Relationship to HIPAA preexisting condition exclusion rules

(b)(3)

☒ ✓

Prohibited discrimination in premiums or contributions - General rule

(c)(1)(i)

☒ ✓

Prohibited discrimination in premiums or contributions - Determining an individual's premium rate

(c)(1)(ii)

☒ ✓

Prohibited discrimination in premiums or contributions - Group rating on health factors not restricted

(c)(2)(i)

☒ ✓

Prohibited discrimination in premiums or contributions - List billing based on a health factor prohibited

(c)(2)(ii) &amp; (iii)

☒ ✓

Prohibited discrimination in premiums or contributions - Exception for bona fide wellness programs

(c)(3)

☒ ✓

Similarly situated individuals

(d)

☒ ✓

Nonconfinement and actively-at-work provisions

(e)

☒ ✓

Bona fide wellness programs

(f) [Reserved.]

See proposed regulations published elsewhere in this Bulletin.

Subject

Paragraph of the Interim Final Regulations

Applies March 9, 2001

Applies plan years beginning on or after 7/1/2001

More favorable treatment of individuals with adverse health factors permitted

(g)

☒ ✓

No effect on other laws

(h)

✓

## IV. Interim Final Regulations with Request for Comments

The principal purpose of these interim
final regulations is to provide additional
guidance on how to comply with the
HIPAA nondiscrimination provisions con-
tained in section 9802 of the Code, section
702 of ERISA, and section 2702 of the
PHS Act. Code section 9833, ERISA sec-
tion 734, and PHS Act section 2792
authorize the Secretaries of the Treasury,
Labor, and HHS to issue any interim final
rules as the Secretaries deem are appro-
priate to carry out certain provisions of
HIPAA, including the nondiscrimination
provisions. As explained below, the
Secretaries have determined that these
regulations should be issued as interim
final rules with requests for comments.

HIPAA was enacted in August of 1996.
The Secretaries first issued interim final
rules providing guidance on HIPAA's
nondiscrimination provisions in April of
1997. In publishing this guidance, the
Secretaries relied on the authority granted
in section 9833 of the Code, section 734
of ERISA, and section 2792 of the PHS
Act, as well as other authority including
section 101(g)(4) of HIPAA and section
505 of ERISA. As part of the April 1997
rulemaking, the Secretaries requested
comments on whether additional guidance
was needed concerning the extent to
which the statutory HIPAA nondiscrimi-
nation provisions prohibit discrimination
against individuals in eligibility for partic-
ular benefits; the extent to which the
statute may permit benefit limitations
based on the source of an injury; the per-
missible standards for defining groups of
similarly situated individuals; the applica-
tion of the prohibitions on discrimination
between groups of similarly situated indi-
viduals; and the permissible standards for
determining bona fide wellness programs.
Numerous comments were received in
response to this request.

After evaluating all of the comments,
and after speaking with various interest-

ed parties in the course of an extensive
educational outreach campaign, the
Departments have developed these com-
prehensive regulations. Among other
things, the comments reflected the need
for more comprehensive guidance on the
application of the nondiscrimination
provisions. In the period since HIPAA
was enacted and the April 1997 regula-
tions were issued, numerous issues have
arisen concerning how plans and issuers
should apply the nondiscrimination pro-
visions. In addition, the number of com-
ments and the breadth of issues raised
demonstrates that these regulations
should go into effect on an interim basis
pending receipt of further comments.
This need to act on an interim basis is
also supported by the General
Accounting Office's request that the
Departments "promptly complete regu-
lations related to HIPAA's non-discrimi-
nation provisions" (GAO/HEHS 00-
85). Therefore, the Departments have
determined that it is appropriate to issue
the guidance on an interim final basis,
with the exception of the bona fide well-
ness program provisions.13 With respect
to these last provisions, the Departments
would like to better develop the admin-
istrative record before any provisions
regarding such programs go into effect.

The Secretaries believe that this period
of interim effectiveness will provide
ample opportunity for the regulated com-
munity to comment specifically on this
comprehensive guidance, providing a
sound basis for developing final rules.
The Departments are seeking comments
from all those affected by these regula-
tions, and the Departments will consider
such comments and will reevaluate these
regulations following the comment period
in the same way that it would if the regu-
lations had been published in proposed
form. Based on such comments and other

13 See proposed rules relating to bona fide wellness
programs published elsewhere in this issue of the
Bulletin.

information obtained through the admin-
istration of the nondiscrimination require-
ments, the Departments will make any
necessary modifications to the regulations
when they are issued in final form.

## V. Economic Impact and Paperwork Burden

### Summary - Department of Labor and Department of Health and Human Services

HIPAA's nondiscrimination provisions
generally prohibit group health plans and
group health plan issuers from discrimi-
nating against individuals in eligibility or
premium on the basis of health status fac-
tors. The Departments crafted this regula-
tion to secure these protections as intend-
ed by Congress in as economically
efficient a manner as possible, and believe
that the economic benefits of the regula-
tion outweigh its costs.

The primary economic benefits associ-
ated with securing HIPAA's nondiscrimi-
nation provisions derive from increased
access to affordable group health plan
coverage for individuals with health prob-
lems. Increased access benefits both
newly covered individuals and society at
large. It fosters expanded insurance cov-
erage, timelier and fuller medical care,
better health outcomes, and improved
productivity and quality of life. This is
especially true for the individuals most
affected by HIPAA's nondiscrimination
provisions - those with adverse health
conditions. Denied insurance, individuals
in poorer health are more likely to suffer
economic hardship, to forgo badly needed
care for financial reasons, and to suffer
adverse health outcomes as a result. For
them, gaining insurance is more likely to
mean gaining economic security, receiv-
ing timely, quality care, and living health-
ier, more productive lives.

Additional economic benefits derive
directly from the improved clarity provid-
ed by the regulation. The regulation will

reduce uncertainty and costly disputes and
promote confidence in health benefits'
value, thereby improving labor market
efficiency and fostering the establishment
and continuation of group health plans.

The Departments estimate that the cost
to plans to implement amendments in
order to comply with this regulation,
revise materials accordingly, and provide
notices of opportunities to enroll as
required by the regulation will amount to
less than $19 million. This is a one-time
cost distinguishable from the transfer that
will result from the self-implementing
requirements of HIPAA's nondiscrimina-
tion provisions and the discretion exer-
cised by the Departments in this regula-
tion.

Such a transfer occurs when resources
are redistributed without any direct
change in aggregate social welfare. In
this instance, the premium and claims cost
incurred by group health plans to provide
coverage under HIPAA's statutory nondis-
crimination provisions to individuals pre-
viously denied coverage or offered
restricted coverage based on health fac-
tors are offset by the commensurate or
greater benefits realized by the newly eli-
gible participants on whose behalf the
premiums or claims are paid. Although
the Departments are not aware of any
published estimates of transfers attribut-
able to HIPAA's statutory nondiscrimina-
tion provisions, a rough attempt to gauge
the order of magnitude of this transfer
suggests that it may amount to more than
$400 million annually, which is a small
fraction of 1 percent of total expenditures
by group plans. The regulation clarifies at
the margin exactly what practices are per-
mitted or prohibited by these provisions,
and may have the effect of slightly
increasing the amount of this transfer.

### Executive Order 12866 - Department of Labor and Department of Health and Human Services

Under Executive Order 12866, the
Departments must determine whether a
regulatory action is "significant" and
therefore subject to the requirements of
the Executive Order and subject to review
by the Office of Management and Budget
(OMB). Under section 3(f), the order
defines a "significant regulatory action"
as an action that is likely to result in a rule
(1) having an annual effect on the econo-

my of $100 million or more, or adversely
and materially affecting a sector of the
economy, productivity, competition, jobs,
the environment, public health or safety,
or State, local or tribal governments or
communities (also referred to as "eco-
nomically significant"); (2) creating seri-
ous inconsistency or otherwise interfering
with an action taken or planned by anoth-
er agency; (3) materially altering the bud-
getary impacts of entitlement grants, user
fees, or loan programs or the rights and
obligations of recipients thereof; or (4)
raising novel legal or policy issues arising
out of legal mandates, the President's pri-
orities, or the principles set forth in the
Executive Order.

Pursuant to the terms of the Executive
Order, it has been determined that this
action raises novel policy issues arising
out of legal mandates. In addition, the
magnitude of the transfer that arises from
the implementation of HIPAA's statutory
nondiscrimination provisions is estimated
to exceed $100 million. Therefore, this
notice is "significant" and subject to
OMB review under Sections 3(f)(1) and
3(f)(4) of the Executive Order. Consistent
with the Executive Order, the
Departments have assessed the costs and
benefits of this regulatory action. The
Departments' assessment, and the analysis
underlying that assessment, is detailed
below. The Departments performed a
comprehensive, unified analysis to esti-
mate the costs and benefits attributable to
the interim regulation for purposes of
compliance with the Executive Order
12866, the Regulatory Flexibility Act, and
the Paperwork Reduction Act.

### 1. Statement of Need for Proposed Action

These interim regulations are needed to
clarify and interpret the HIPAA nondis-
crimination provisions (prohibiting dis-
crimination against individual participants
and beneficiaries based on health status)
under section 702 of the Employee
Retirement Income Security Act of 1974
(ERISA), section 2702 of the Public
Health Service Act, and section 9802 of
the Internal Revenue Code of 1986. The
provisions are needed to ensure that group
health plans and group health insurers and
issuers do not discriminate against indi-
viduals, participants, and beneficiaries
based on any health factors with respect to

health care coverage and premiums.
Additional guidance was required to
explain the application of the statute to
benefits, clarify the relationship between
the HIPAA nondiscrimination provisions
and the HIPAA preexisting condition
exclusion limitations, explain the applica-
tions of these provisions to premiums,
describe similarly situated individuals,
explain the application of the provisions
to actively-at-work and nonconfinement
clauses, clarify that more favorable treat-
ment of individuals with medical needs
generally is permitted, and describe plans'
and issuers' obligations with respect to
plan amendments.

## 2. Costs and Benefits

The primary economic benefits associ-
ated with the HIPAA nondiscrimination
provisions derive from increased access to
affordable group health plan coverage for
individuals with health problems.
Expanding access benefits both newly
covered individuals and society at large
by fostering expanded insurance cover-
age, timelier and fuller medical care, bet-
ter health outcomes, and improved pro-
ductivity and quality of life. Additional
economic benefits derive directly from
the improved clarity provided by the reg-
ulation. By clarifying employees' rights
and plan sponsors' obligations under
HIPAA's nondiscrimination provisions,
the regulation will reduce uncertainty and
costly disputes and promote confidence in
health benefits' value, thereby improving
labor market efficiency and fostering the
establishment and continuation of group
health plans.

Such a transfer occurs when resources
are redistributed without any direct
change in aggregate social welfare. In
this instance, the premium and claims cost
incurred by group health plans to provide

coverage under HIPAA's statutory nondis-
crimination provisions to individuals pre-
viously denied coverage or offered
restricted coverage based on health fac-
tors are offset by the commensurate or
greater benefits realized by the newly eli-
gible participants on whose behalf the
premiums or claims are paid. Although
the Departments are not aware of any
published estimates of transfers attribut-
able to HIPAA's statutory nondiscrimina-
tion provisions, a rough attempt to gauge
the order of magnitude of this transfer
suggests that it may amount to more than
$400 million annually. The regulation
clarifies at the margin exactly what prac-
tices are permitted or prohibited by these
provisions, and may have the effect of
slightly increasing the amount of this
transfer. The Departments note that this
transfer is the direct reflection of the
intent and beneficial effect of HIPAA's
nondiscrimination provisions: increasing
access to affordable group health plan
coverage for individuals with health prob-
lems. They also note that even the full
transfer to plans attributable to HIPAA's
statutory nondiscrimination provisions
probably amounts to a small fraction of 1
percent of total expenditures by these
plans.

The Departments believe that the
benefits of the regulation outweigh its
costs.

A fuller discussion of the Departments
assessment of the costs and benefits of
this regulation is provided below.

### Regulatory Flexibility Act

The Regulatory Flexibility Act (5
U.S.C. 601 et seq.) (RFA) imposes certain
requirements with respect to Federal rules
that are subject to the notice and comment
requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C.
551 et seq.) and likely to have a signifi-
cant economic impact on a substantial
number of small entities. Unless an
agency certifies that a proposed rule will
not have a significant economic impact on
a substantial number of small entities, sec-
tion 603 of the RFA requires that the
agency present an initial regulatory flexi-
bility analysis at the time of the publica-
tion of the notice of proposed rule making
describing the impact of the rule on small
entities and seeking public comment on
such impact. Small entities include small

businesses, organizations, and govern-
mental jurisdictions.

Because these rules are being issued as
interim final rules and not as a notice of
proposed rule making, the RFA does not
apply and the Departments are not
required to either certify that the rule will
not have a significant impact on a sub-
stantial number of small businesses or
conduct a regulatory flexibility analysis.
The Departments nonetheless crafted this
regulation in careful consideration of its
effects on small entities, and have con-
ducted an analysis of the likely impact of
the rules on small entities.

For purposes of this discussion, the
Departments consider a small entity to be
an employee benefit plan with fewer than
100 participants. The basis of this defini-
tion is found in section 104(a)(2) of
ERISA, which permits the Secretary of
Labor to prescribe simplified annual
reports for pension plans which cover
fewer than 100 participants. The
Departments believe that assessing the
impact of this interim final rule on small
plans is an appropriate substitute for eval-
uating the effect on small entities as that
term is defined in the RFA.

Small plans in particular will benefit
from the regulations' provisions that
affirm and clarify the flexibility available
to plans under HIPAA's nondiscrimina-
tion requirements. Consideration of small
plans' needs and circumstances played an
important part in the development these
provisions. These provisions are dis-
cussed in more detail below.

The Departments estimate that plans
with 100 or fewer participants will incur
costs of $4 million on aggregate to amend
their provisions to comply with the regu-
lation and revise their materials accord-
ingly. These costs generally will fall
directly to issuers who supply small group
insurance products and stop-loss insurers
who provide services to small self-insured
plans, who will spread those costs across
the much larger number of small plans
that buy them. These same small plans
will incur costs of $10 million to prepare
and distribute notices of enrollment
opportunities as required by the regula-
tion, the Departments estimate. The total
economic cost to small plans to comply
with this regulation is estimated to be $14
million. This is a one-time cost distin-
guishable from the transfer that will result

from the self-implementing requirements
of HIPAA's nondiscrimination provisions
and the discretion exercised by the
Departments in this regulation

Such a transfer occurs when resources
are redistributed without any direct
change in aggregate social welfare. In
this instance, the premium and claims cost
incurred by group healh plans to provide
coverage under HIPAA's statutory nondis-
crimination provisions to individuals pre-
viously denied coverage or offered
restricted coverage based on health fac-
tors are offset by the commensurate or
greater benefits realized by the newly eli-
gible participants on whose behalf the
premiums or claims are paid. The
Departments note that transfers to small
plans attributable to HIPAA's statutory
nondiscrimination provisions may
amount to approximately $110 million.
The regulation clarifies at the margin
exactly what practices are permitted or
prohibited by these provisions, and may
have the effect of slightly increasing the
amount of this transfer. The Departments
note that this transfer is the direct reflec-
tion of the intent and beneficial effect of
HIPAA's nondiscrimination provisions:
increasing access to affordable group
health plan coverage for individuals with
health problems. They also note that even
the full transfer to small plans attributable
to HIPAA's statutory nondiscrimination
provisions amounts to a small fraction of
total expenditures by these plans.

### Paperwork Reduction Act - Department of Labor and Department of the Treasury

#### 1. Department of Labor

The Department of Labor, as part of its
continuing effort to reduce paperwork and
respondent burden, conducts a preclearance
consultation program to provide the gener-
al public and federal agencies with an
opportunity to comment on proposed and
continuing collections of information in
accordance with the Paperwork Reduction
Act of 1995 (PRA 95), 44 U.S.C.
3506(c)(2)(A). This helps to ensure that
requested data can be provided in the
desired format, reporting burden (time and
financial resources) is minimized, collec-
tion instruments are clearly understood, and
the impact of collection requirements on
respondents can be properly assessed.

Currently, the Pension and Welfare
Benefits Administration (PWBA) is
soliciting comments concerning the pro-
posed information collection request
(ICR) included in the Interim Final Rules
for Nondiscrimination in Health Coverage
in the Group Market.

The Department has submitted this ICR
using emergency review procedures to the
Office of Management and Budget
(OMB) for its review and clearance in
accordance with PRA 95. OMB approval
has been requested by March 9, 2001.
The Department and OMB are particular-
ly interested in comments that:

· Evaluate whether the proposed
collection of information is neces-
sary for the proper performance
of the functions of the agency,
including whether the information
will have practical utility;

· Evaluate the accuracy of the
agency's estimate of the burden of
the proposed collection of infor-
mation, including the validity of
the methodology and assumptions
used;

· Enhance the quality, utility, and
clarity of the information to be
collected; and

· Minimize the burden of the col-
lection of information on those
who are to respond, including
through the use of appropriate
automated, electronic, mechani-
cal, or other technological collec-
tion techniques or other forms of
information technology, e.g., per-
mitting electronic submission of
the responses.

Comments on the collection of infor-
mation should be sent to the Office of
Information and Regulatory Affairs,
Office of Management and Budget,
Room 10235, New Executive Office
Building, Washington, DC 20503;
Attention: Desk Officer for the Pension
and Welfare Benefits Administration.
Although comments may be submitted
through March 9, 2001, OMB requests
that comments be received by February 7,
2001, to ensure their consideration in
OMB's review of the request for emer-
gency approval. All comments will be
shared among the Departments.

Requests for copies of the ICR may be
addressed to: Gerald B. Lindrew, Office
of Policy and Research, U.S. Department

of Labor, Pension and Welfare Benefits
Administration, 200 Constitution Avenue,
NW, Room N-5647, Washington, D.C.,
20210. Telephone: (202) 219-4782; Fax:
(202) 219-4745 (these are not toll-free
numbers).

## 2. Department of the Treasury

The collection of information is in 26
CFR 54.9802-1T(i)(3)(ii) and (iii). This
information is required to be provided so
that participants who have been denied
group health plan coverage based on a
health status factor may be made aware of
the opportunity to enroll in the plan. The
likely respondents are business or other
for-profit institutions, non-profit institu-
tions, small businesses or organizations,
and Taft-Hartley trusts. Responses to this
collection of information are mandatory
for affected group health plans.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.

Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC,
20503, with copies to the Internal
Revenue Service, Attn: IRS Reports
Clearance Officer, W:CAR:MP:FP:S:O,
Washington, DC 20224. Comments on
the collection of information should be
received by February 7, 2001. In light of
the request for OMB clearance by March
9, 2001, the early submission of com-
ments is encouraged to ensure their con-
sideration. Comments are specifically
requested concerning:

· Whether the proposed collection
of information is necessary for the
proper performance of the func-
tions of the Internal Revenue
Service, including whether the
information will have practical
utility;

· How to enhance the quality, utili-
ty, and clarity of the information
to be collected;

· How to minimize the burden of
complying with the proposed col-
lection of information, including

the application of automated col-
lection techniques or other forms
of information technology; and

· Estimates of capital or start up
costs and costs of operation,
maintenance, and purchase of ser-
vices to provide information.

## 3. Description of Collection of Information

29 CFR 2590.702(i)(3)(ii) and (iii)
and 26 CFR 54.9802-1T(i)(3)(ii) and
(iii) of these interim rules include infor-
mation collection requests. Paragraphs
(i)(3)(ii) and (iii) describe the require-
ment that individuals previously denied
coverage under a group health plan be
provided with an opportunity to enroll in
the plan, and a notice concerning this
opportunity. Pursuant to paragraph
(i)(3)(ii), where coverage denials were
not based on a good faith interpretation
of section 702 of the ERISA and section
9802 of the Code, notices of the oppor-
tunity for individuals previously denied
coverage to enroll are required to be pro-
vided within 60 days of publication of
this interim final rule. Where coverage
was denied based on a good faith inter-
pretation of section 702 of ERISA and
section 9802 of the Code, the plan or
issuer must provide notice of the oppor-
tunity to enroll that continues for at least
30 days, with coverage effective no later
than July 1, 2001.

The method of estimating the hour and
cost burdens of the information collection
request is described in the section of this
preamble appearing below entitled Costs
and Benefits of the Regulation. Generally,
the Departments have conservatively esti-
mated that all group health plans that
excluded individuals on the basis of
health status factors prior to HIPAA's
enactment will provide a notice of the
opportunity to enroll to all participants.
The total burden of providing notices to
participants of private employers is divid-
ed equally between the Departments of
Labor and Treasury.

Paragraph (h), No effect on other laws,
is not considered to include an informa-
tion collection request because the provi-
sion makes no substantive or material
change to the Department of Labor's
existing information collection request for
the Summary Plan Description and
Summary of Material Modifications cur-

rently approved under OMB control num-
ber 1210-0039.

Type of Review: New

Agency: Pension and Welfare Benefits
Administration, Department of Labor;
U.S. Department of the Treasury, Internal
Revenue Service

Title: Notice of Opportunity To Enroll
OMB Number: 1210- 0NEW; 1545-0NEW
Affected Public: Individuals or house-
holds; Business or other for-profit institu-
tions; Not-for-profit institutions
Total Respondents: 120,000
Frequency of Response: One time
Total Responses: 2.0 million
Estimated Burden Hours: 5,950 (Pension
and Welfare Benefits Administration);
5,950 (Internal Revenue Service)

Estimated Annual Costs (Operating and
Maintenance): $5.1 million (Pension
and Welfare Benefits Administration);
$5.1 million (Internal Revenue Serv
ice)

Estimated Total Annual Costs: $5.1 mil-
lion (Pension and Welfare Benefits
Administration); $5.1 million (Internal
Revenue Service)

Comments submitted in response to the
information collection provisions of these
Interim Final, final, and temporary rules
will be shared among the Departments
and summarized and/or included in the
request for continuing OMB approval of
the information collection request; they
will also become a matter of public
record.

## Paperwork Reduction Act - Department of Health and Human Services

Under the Paperwork Reduction Act of
1995 (PRA), agencies are required to pro-
vide a 60-day notice in the Federal
Register and solicit public comment
before a collection of information
requirement is submitted to the OMB for
review and approval. In order to fairly
evaluate whether an information collec-
tion should be approved by OMB, section
3506(c)(2)(A) of the PRA requires that
we solicit comment on the following
issues:

· Whether the information collec-
tion is necessary and useful to
carry out the proper functions of
the agency;

· The accuracy of the agency's esti-
mate of the information collection
burden;

· The quality, utility, and clarity of
the information to be collected;
and

· Recommendations to minimize
the information collection burden
on the affected public, including
automated collection techniques.

We are, however, requesting an emer-
gency review of this interim final rule
with comment period. In compliance with
section 3506(c)(2)(A) of the PRA, we are
submitting to OMB the following require-
ments for emergency review. We are
requesting an emergency review because
the collection of this information is need-
ed before the expiration of the normal
time limits under OMB's regulations at 5
CFR Part 1320, to ensure compliance with
section 2702 of the PHS Act. This section
generally prohibits group health plans and
group health insurance issuers from dis-
criminating against individual participants
or beneficiaries based on any health factor
of such participants or beneficiaries. We
cannot reasonably comply with normal
clearance procedures because public harm
is likely to result if the agency cannot
enforce the requirements of this section
2702 of the PHS Act in order to ensure
that individual participants or beneficia-
ries are not subject to unfair discrimina-
tion.

HCFA is requesting OMB review and
approval of this collection 60 working days
after the publication of this rule, with a
180-day approval period. Written com-
ments and recommendations will be accept-
ed from the public if received by the indi-
viduals designated below within 30 working
days after the publication of this rule.

During this 180-day period, we will
publish a separate Federal Register
notice announcing the initiation of an
extensive 60-day agency review and pub-
lic comment period on these require-
ments. We will submit the requirements
for OMB review and an extension of this
emergency approval.

We are soliciting public comment on
each of the issues for the provisions sum-
marized below that contain information
collection requirements:

Section 146.121 Prohibiting
discrimination against participants and
beneficiaries based on a health factor.

(h) No effect on other laws Although this
section generally does not impose new

disclosure obligations on plans and
issuers, this paragraph (h) states that this
section does not affect any other laws,
including those that require accurate dis-
closures and prohibit intentional misrep-
resentation. Therefore, plan documents
(including, for example, group health
insurance policies and certificates of
insurance) must be amended if they do not
accurately reflect the requirements set
forth in this section, by the applicability
date of this section.

The revisions to the plan documents are
intended to eliminate provisions that do
not comply with the HIPAA nondiscrimi-
nation statute and regulations. In particu-
lar, it is anticipated that changes will be
required to the majority of actively-at-
work provisions and nonconfinement
clauses found in plan documents. The
modifications are to be made by the
applicability date of the regulation and the
requirements do not impose any on-going
burden. The revisions are anticipated to
take 100 hours for state governmental
plans and 4,900 hours for local govern-
mental plans. The changes are expected to
involve one hour of an attorney's time at a
$72 hourly rate. The corresponding plan
amendment cost to be performed by ser-
vice providers who are acting on behalf of
the plans, is $32,000 for State govern-
mental plans and $1,311,000 for local
governmental plans.

(i) Special transitional rule for self-fund-
ed non-Federal governmental plans
exempted under 45 CFR 146.180.
Paragraph (4)(i) requires that if coverage
has been denied to any individual because
the sponsor of a self-funded non-Federal
governmental plan has elected under §
146.180 of this part to exempt the plan
from the requirements of this section, and
the plan sponsor subsequently chooses to
bring the plan into compliance with the
requirements of this section, the plan
must: notify the individual that the plan
will be coming into compliance with the
requirements of this section; afford the
individual an opportunity that continues
for at least 30 days, specify the effective
date of compliance; and inform the indi-
vidual regarding any enrollment restric-
tions that may apply under the terms of
the plan once the plan is in compliance
with this section (as a matter of adminis-
trative convenience; the notice may be
disseminated to all employees).

The regulation clarifies that self-funded
non-Federal governmental plans are
required to give individuals who were
previously discriminated against an
opportunity to enroll, including notice of
an opportunity to enroll. The develop-
ment of the number of plans that are
required to notify individuals were con-
servatively arrived at by assuming that all
plans which have excluded individuals
must notify all individuals who are eligi-
ble to participate in the plan.
Development of the transitional notices
are estimated to take 0 hours for State
governmental plans and 200 hours for
local governmental plans. The corre-
sponding burden for work performed by
service providers is anticipated to be
$1,000 for State governmental plans and
$535,000 for local governmental plans.
The Department estimates that the burden
to distribute transitional notices will
require State governmental plans 800
hours and 1,400 hours for local govern-
mental plans. The corresponding distrib-
ution burden performed by service
providers is $72,000 for State governmen-
tal plans and $158,000 for local govern-
mental plans.

The above costs will be reduced to the
extent that State and local governmental
plans have elected to opt out of the
HIPAA requirements. As of the date of
publishing, approximately 600 plans have
opted out of the HIPAA statutory and reg-
ulatory requirements.

We have submitted a copy of this rule
to OMB for its review of the information
collection requirements. These require-
ments are not effective until they have
been approved by OMB. A notice will be
published in the Federal Register when
approval is obtained.

If you comment on any of these infor-
mation collection and record keeping
requirements, please mail copies directly
to the following:

Health Care Financing Administration,
Office of Information Services,
Information Technology Investment
Management Group,
Division of HCFA Enterprise Stand-
ards,

Room C2-26-17,
7500 Security Boulevard,
Baltimore, MD 21244-1850,
Attn: John Burke HCFA-2022,
and

Office of Information and Regulatory
Affairs,
Office of Management and Budget,
Room 10235, New Executive Office
Building,
Washington, DC 20503,
Attn .: Allison Herron Eydt, HCFA-
2022.

## Small Business Regulatory Enforcement Fairness Act

This interim final rule is subject to the
provisions of the Small Business
Regulatory Enforcement Fairness Act of
1996 (5 U.S.C. 801 et seq.) and is being
transmitted to Congress and the
Comptroller General for review. The
interim final rule is a "major rule," as that
term is defined in 5 U.S.C. 804, because it
is likely to result in an annual effect on the
economy of $100 million or more. As
such, this interim final rule is being trans-
mitted to Congress and the Comptroller
General for review.

## Unfunded Mandates Reform Act

For purposes of the Unfunded
Mandates Reform Act of 1995 (Pub. L.
104-4), as well as Executive Order
12875, this interim final rule does not
include any Federal mandate that may
result in expenditures by State, local, or
tribal governments, nor does it include
mandates which may impose an annual
burden of $100 million or more on the pri-
vate sector.

## Federalism Statement - Department of Labor and Department of Health and Human Services

Executive Order 13132 (August 4,
1999) outlines fundamental principles of
federalism, and requires the adherence to
specific criteria by federal agencies in the
process of their formulation and imple-
mentation of policies that have substantial
direct effects on the States, the relation-
ship between the national government and
States, or on the distribution of power and
responsibilities among the various levels
of government. Agencies promulgating
regulations that have these federalism
implications must consult with State and
local officials, and describe the extent of
their consultation and the nature of the
concerns of State and local officials in the
preamble to the regulation.

In the Departments' view, these interim
final regulations do not have federalism
implications, because they do not have
substantial direct effects on the States, the
relationship between the national govern-
ment and States, or on the distribution of
power and responsibilities among various
levels of government. This is largely
because, with respect to health insurance
issuers, the vast majority of States have
enacted laws which meet or exceed the
federal standards in HIPAA prohibiting
discrimination based on health factors.
Therefore, the regulations are not likely to
require substantial additional oversight of
States by the Department of Health and
Human Services.

In general, through section 514, ERISA
supersedes State laws to the extent that
they relate to any covered employee ben-
efit plan, and preserves State laws that
regulate insurance, banking, or securities.
While ERISA prohibits States from regu-
lating a plan as an insurance or investment
company or bank, HIPAA added a new
preemption provision to ERISA (as well
as to the PHS Act) preserving the applica-
bility of State laws establishing require-
ments for issuers of group health insur-
ance coverage, except to the extent that
these requirements prevent the application
of the portability, access, and renewabili-
ty requirements of HIPAA. The nondis-
crimination provisions that are the subject
of this rulemaking are included among
those requirements.

In enacting these new preemption
provisions, Congress indicated its intent
to establish a preemption of State insur-
ance requirements only to the extent
that those requirements prevent the
application of the basic protections set
forth in HIPAA. HIPAA's Conference
Report states that the conferees intended
the narrowest preemption of State laws
with regard to health insurance issuers.
H.R. Conf. Rep. No. 736, 104th Cong.
2d Session 205 (1996). Consequently,
under the statute and the Conference
Report, State insurance laws that are
more stringent than the federal require-
ments are unlikely to "prevent the appli-
cation of" the HIPAA nondiscrimination
provisions.

Accordingly, States are given signifi-
cant latitude to impose requirements on
health insurance issuers that are more
restrictive than the federal law. In many

cases, the federal law imposes minimum
requirements which States are free to
exceed. Guidance conveying this inter-
pretation was published in the Federal
Register on April 8, 1997, and these
regulations do not reduce the discretion
given to the States by the statute. It is
the Departments' understanding that the
vast majority of States have in fact
implemented provisions which meet or
exceed the minimum requirements of
the HIPAA non-discrimination provi-
sions.

HIPAA provides that the States may
enforce the provisions of HIPAA as they
pertain to issuers, but that the Secretary of
Health and Human Services must enforce
any provisions that a State fails to sub-
stantially enforce. When exercising its
responsibility to enforce the provisions of
HIPAA, HCFA works cooperatively with
the States for the purpose of addressing
State concerns and avoiding conflicts with
the exercise of State authority.14 HCFA
has developed procedures to implement
its enforcement responsibilities, and to
afford the States the maximum opportuni-
ty to enforce HIPAA's requirements in the
first instance. HCFA's procedures address
the handling of reports that States may not
be enforcing HIPAA's requirements, and
the mechanism for allocating enforcement
responsibility between the States and
HCFA. To date, HCFA has had occasion
to enforce the HIPAA non-discrimination
provisions in only two States.

Although the Departments conclude
that these interim final rules do not have
federalism implications, in keeping with
the spirit of the Executive Order that
agencies closely examine any policies that
may have federalism implications or limit
the policy making discretion of the States,
the Department of Labor and HCFA have

engaged in numerous efforts to consult
with and work cooperatively with affected
State and local officials.

For example, the Departments were
aware that some States commented on the
way the federal provisions should be
interpreted. Therefore, the Departments
have sought and received input from State
insurance regulators and the National
Association of Insurance Commissioners
(NAIC). The NAIC is a non-profit corpo-
ration established by the insurance com-
missioners of the 50 States, the District of
Columbia, and the four U.S. territories,
that among other things provides a forum
for the development of uniform policy
when uniformity is appropriate. Its mem-
bers meet, discuss, and offer solutions to
mutual problems. The NAIC sponsors
quarterly meetings to provide a forum for
the exchange of ideas, and in-depth con-
sideration of insurance issues by regula-
tors, industry representatives, and con-
sumers. HCFA and Department of Labor
staff have attended the quarterly meetings
consistently to listen to the concerns of
the State Insurance Departments regard-
ing HIPAA issues, including the nondis-
crimination provisions. In addition to the
general discussions, committee meetings
and task groups, the NAIC sponsors the
following two standing HIPAA meetings
for members during the quarterly confer-
ences:

· HCFA/DOL Meeting on HIPAA
Issues (This meeting provides
HCFA and Labor the opportunity
to provide updates on regulations,
bulletins, enforcement actions and
outreach efforts regarding
HIPAA.)

· The NAIC/HCFA Liaison
Meeting (This meeting provides
HCFA and the NAIC the opportu-
nity to discuss HIPAA and other
health care programs.)

In addition, in developing these interim
final regulations, the Departments con-
sulted with the NAIC and requested their
assistance to obtain information from the
State Insurance Departments. Specifi-
cally, we sought and received their input
on certain insurance rating practices and
late enrollment issues. The Departments
employed the States' insights on insur-
ance rating practices in developing the
provisions prohibiting "list-billing," and
their experience with late enrollment in

crafting the regulatory provision clarify-
ing the relationship between the nondis-
crimination provisions and late enroll-
ment. Specifically, the regulations clarify
that while late enrollment, if offered by a
plan, must be available to all similarly sit-
uated individuals regardless of any health
factor, an individual's status as a late
enrollee is not itself within the scope of
any health factor.

The Departments also cooperate with
the States in several ongoing outreach ini-
tiatives, through which information on
HIPAA is shared among federal regula-
tors, State regulators, and the regulated
community. In particular, the Department
of Labor has established a Health Benefits
Education Campaign with more than 70
partners, including HCFA, NAIC and
many business and consumer groups.
HCFA has sponsored four conferences
with the States - the Consumer Outreach
and Advocacy conferences in March 1999
and June 2000, the Implementation and
Enforcement of HIPAA National State-
Federal Conferences in August 1999 and
2000. Furthermore, both the Department
of Labor and HCFA websites offer links to
important State websites and other
resources, facilitating coordination
between the State and federal regulators
and the regulated community.

In conclusion, throughout the process
of developing these regulations, to the
extent feasible within the specific pre-
emption provisions of HIPAA, the
Departments have attempted to balance
the States' interests in regulating health
insurance issuers, and Congress's intent to
provide uniform minimum protections to
consumers in every State.

## Unified Analysis of Costs and Benefits

### 1. Introduction

HIPAA's nondiscrimination provisions
generally prohibit group health plans and
group health plan issuers from discrimi-
nating against individuals on the basis of
health status factors. The primary effect
and intent of the provision is to increase
access to affordable group health cover-
age for individuals with health problems.
This effect, and the economic costs, bene-
fits, and transfers attendant to it, general-
ly flow directly from the HIPAA's statuto-
ry provisions, which are largely
self-implementing. However, the statute

14 This authority applies to insurance issued with
respect to group health plans generally, including
plans covering employees of church organizations.
Thus, this discussion of federalism applies to all
group health insurance coverage that is subject to the
PHS Act, including those church plans that provide
coverage through a health insurance issuer (but not
to church plans that do not provide coverage through
a health insurance issuer). For additional informa-
tion relating to the application of these nondiscrimi-
nation rules to church plans, see the preamble to reg-
ulations being proposed elsewhere in this issue of the
Bulletin regarding section 9802(c) of the Code relat-
ing to church plans.

alone leaves room for varying interpreta-
tions of exactly which practices are pro-
hibited or permitted at the margin. This
regulation draws on the Departments'
authority to clarify and interpret HIPAA's
statutory nondiscrimination provisions in
order to secure the protections intended
by Congress for plan participants and ben-
eficiaries. The Departments crafted it to
satisfy this mandate in as economically
efficient a manner as possible, and believe
that the economic benefits of the regula-
tion outweigh its costs. The analysis
underlying this conclusion takes into
account both the effect of the statute and
the impact of the discretion exercised in
the regulation.

The nondiscrimination provisions of
the HIPAA statute and of this regulation
generally apply to both group health plans
and to issuers of group health plan poli-
cies. Economic theory predicts that
issuers will pass their costs of compliance
back to plans, and that plans may pass
some or all of issuers' and their own costs
of compliance to participants. This analy-
sis is carried out in light of this prediction.

### 2. Costs and Benefits of HIPAA's Statutory Nondiscrimination Provisions

As noted above, HIPAA's statutory
nondiscrimination provisions are largely
self-implementing even in the absence of
interpretive guidance. It is the Depart-
ments' policy where practicable to evalu-
ate such impacts separately from the
impact of discretion exercised in regula-
tion. The Departments provide qualitative
assessments of the nature of the costs,
benefits, and transfers that are expected to
derive from statutory provisions, and pro-
vide summaries of any credible, empirical
estimates of these effects that are avail-
able.

To the Departments' knowledge, there
is no publicly available work that quanti-
fies the magnitude or presents the nature
of these benefits, costs, and transfers. In
its initial scoring of the statute, the
Congressional Budget Office did not sep-
arately quantify the costs of the nondis-
crimination provisions. Therefore, this
analysis considers the nature of anticipat-
ed costs, benefits, and transfers, and offers
a basis for estimating separately the
impacts of the statute and regulatory dis-
cretion, but does not present a detailed
description of any other quantitative

analysis of the statute's impact.

HIPAA's statutory nondiscrimination
provisions entail new economic costs and
benefits, as well as transfers of health care
costs among plan sponsors and participants.

The primary statutory economic bene-
fits associated with the HIPAA nondis-
crimination provisions derive from
increased access to affordable group
health plan coverage for individuals with
certain health status-related factors.
Expanding access benefits both newly
covered individuals and society at large.
Individuals without health insurance are
less likely to get preventive care and less
likely to have a regular source of care.15
A lack of health insurance generally
increases the likelihood that needed med-
ical treatment will be forgone or delayed.
Forgoing or delaying care increases the
risk of adverse health outcomes. These
adverse outcomes in turn spawn higher
medical costs which are often shifted to
public funding sources (and therefore to
taxpayers) or to other payers. They also
erode productivity and the quality of life.
Improved access to affordable group
health coverage for individuals with
health problems under HIPAA's nondis-
crimination provisions will lead to more
insurance coverage, timelier and fuller
medical care, better health outcomes, and
improved productivity and quality of life.
This is especially true for the individuals
most affected by HIPAA's nondiscrimina-
tion provisions - those with adverse
health conditions. Denied insurance, indi-
viduals in poorer health are more likely to
suffer economic hardship, to forgo badly
needed care for financial reasons, and to
suffer adverse health outcomes as a result.
For them, gaining insurance is more like-
ly to mean gaining economic security,
receiving timely, quality care, and living
healthier, more productive lives.

Plans and issuers will incur economic
costs as a result of the law. These are gen-
erally limited to administrative costs, such
as those incurred to change plan design
and pricing structures and update plan
materials.

The premiums and claims costs incurred
by group health plans to provide coverage

to individuals who were previously denied
coverage or offered restricted coverage
based on health factors are offset by the
commensurate or greater benefits realized
by the newly eligible participants on whose
behalf the premiums or claims are paid.
As such, these premiums and claims costs
are properly characterized as transfers
rather than as new economic costs. These
transfers shift the burden of health care
costs from one party to another without any
direct change in aggregate social welfare.
For example, as individuals' insurance sta-
tus changes from insured through an indi-
vidual policy to insured though an employ-
ment based group health plan, health care
costs are transferred from these individuals
to their employers. Similarly, as individu-
als' insurance status changes from unin-
sured to insured through a group health
plan, health care costs are transferred from
the individuals and public funding sources
to employers.

The HIPAA nondiscrimination statuto-
ry transfer is likely to be substantial.
Annual per-participant group health plan
costs average more than $4,00016, and it is
likely that average costs would be higher
for individuals who had faced discrimina-
tion due to health status factors. Prior to
HIPAA's enactment approximately
106,000 employees were denied employ-
ment based coverage because of health
factors.17 A simple assessment suggests
that the total cost of coverage for such
employees could exceed $400 million.
However, this potential statutory transfer
is small relative to the overall cost of
employment-based health coverage.
Group health plans will spend about $431
billion this year to cover approximately
77 million participants and their depen-
dents. Transfers under HIPAA's nondis-
crimination provision will represent a
very small fraction of one percent of total
group health plan expenditures.

### 3. Costs and Benefits of the Regulation

Prohibiting Discrimination - Many of
the provisions of this regulation serve to
specify more precisely than the statute

15 Kaiser Family Foundation and The NewsHour,
"NewsHour/Kaiser Spotlights Misconceptions
About the Medically Uninsured: Survey Examines
Difficulties Faced by Those Without Health
Coverage," News Release, May 16, 2000.

16 Gabel, Jon R. Job-based Health Insurance, 1977-
1998: The Accidental System Under Scrutiny.
Health Affairs. November / December 1999. Volume
18, Number 6.

17 February 1997 Current Population Survey,
Contingent Worker Supplement.

alone exactly what practices are prohibit-
ed by HIPAA as unlawful discrimination
in eligibility or employee premium among
similarly situated employees. For exam-
ple, under the regulation eligibility gener-
ally may not be restricted based on an
individuals' participation in risky activi-
ties, confinement to an institution or
absence from work on enrollment day due
to illness, or status as a late enrollee. The
regulation provides that various plan fea-
tures including waiting periods and eligi-
bility for certain benefits constitute rules
for eligibility which may not vary across
similarly situated employees based on
health status factors. It provides that indi-
viduals who were previously denied eligi-
bility based on health status factors (or
who failed to enroll in anticipation of such
denial) must be given an opportunity to
enroll. It provides that plans may not
reclassify employees based on health sta-
tus factors in order to create separate
groups of similarly situated employees
among which discrimination would be
permitted.

All of these provisions have the effect
of clarifying and ensuring certain partici-
pants' right to freedom from discrimina-
tion in eligibility and premium amounts,
thereby securing their access to affordable
group health plan coverage. The costs
and benefits attributable to these provi-
sions resemble those attendant to HIPAA's
statutory nondiscrimination provisions.
Securing participants' access to affordable
group coverage provides economic bene-
fits by reducing uninsurance and thereby
improving health outcomes. It entails
transfers of costs from the employees
whose rights are secured (and/or from
other parties who would otherwise pay for
their health care) to plan sponsors (or to
other plan participants if sponsors pass
those costs back evenly to them). And it
imposes economic costs in the form of
administrative burdens to design and
implement necessary plan amendments.

The Departments lack any basis on
which to distinguish these benefits, costs,
and transfers from those of the statute
itself. It is unclear how many plans might
be engaging in the discriminatory prac-
tices targeted for prohibition by these reg-
ulatory provisions. Because these provi-
sions operate largely at the margin of the
statutory requirements, it is likely that the
effects of these provisions will be far

smaller than the similar statutory effects.
The Departments are confident, however,
that by securing employees' access to
affordable coverage at the margin, the
regulation, like the statute, will yield ben-
efits in excess of costs.

Clarifying Requirements - Additional
economic benefits derive directly from
the improved clarity provided by the reg-
ulation. The regulation provides clarity
through both its provisions and its exam-
ples of how those provisions apply in var-
ious circumstances. By clarifying
employees' rights and plan sponsors'
obligations under HIPAA's nondiscrimi-
nation provisions, the regulation will
reduce uncertainty and costly disputes
over these rights and obligations. It will
promote employers' and employees' com-
mon understanding of the value of group
health plan benefits and confidence in the
security and predictability of those bene-
fits, thereby improving labor market effi-
ciency and fostering the establishment
and continuation of group health plans by
employers.18

18 The voluntary nature of the employment-based
health benefit system in conjunction with the open
and dynamic character of labor markets make
explicit as well as implicit negotiations on compen-
sation a key determinant of the prevalence of
employee benefits coverage. It is likely that 80% to
100% of the cost of employee benefits is borne by
workers through reduced wages (see for example
Jonathan Gruber and Alan B. Krueger, "The
Incidence of Mandated Employer-Provided
Insurance: Lessons from Workers Compensation
Insurance," Tax Policy and Economy (1991);
Jonathan Gruber, "The Incidence of Mandated
Maternity Benefits," American Economic Review,
Vol. 84 (June 1994), pp. 622-641; Lawrence H.
Summers, "Some Simple Economics of Mandated
Benefits," American Economic Review, Vol. 79, No.
2 (May 1989); Louise Sheiner, "Health Care Costs,
Wages, and Aging," Federal Reserve Board of
Governors working paper, April 1999; and Edward
Montgomery, Kathryn Shaw, and Mary Ellen
Benedict, "Pensions and Wages: An Hedonic Price
Theory Approach," International Economic Review,
Vol. 33 No. 1, Feb. 1992.) The prevalence of bene-
fits is therefore largely dependent on the efficacy of
this exchange. If workers perceive that there is the
potential for inappropriate denial of benefits, they
will discount their value to adjust for this risk. This
discount drives a wedge in the compensation negoti-
ation, limiting its efficiency. With workers unwilling
to bear the full cost of the benefit, fewer benefits will
be provided. The extent to which workers perceive
a federal regulation supported by enforcement
authority to improve the security and quality of ben-
efits, the differential between the employers costs
and workers willingness to accept wage offsets is
minimized.

Amending Plans - The regulation is
expected to entail some new economic
costs, in the form of two new administra-
tive burdens, which are distinguishable
from those attributable to the statute. First,
it is likely that some of the regulation's
nondiscrimination provisions will effec-
tively require some plans to amend their
terms and revise plan materials. Second, as
noted above, the regulation requires that
individuals who were previously denied
eligibility based on health status factors (or
who failed to enroll in anticipation of such
denial) must be given an opportunity to
enroll. It also requires that plans notify
such individuals of their right of enroll.
Providing notices under these requirements
will entail new administrative costs.

Plans that, prior to HIPAA's effective
date, included provisions since prohibited
by HIPAA's nondiscrimination require-
ments, were effectively required by HIPAA
to implement conforming amendments and
to revise plan materials accordingly. The
costs associated with these actions general-
ly are attributable to the HIPAA statute and
not to this regulation. However, it is likely
that some of the regulation's nondiscrimi-
nation provisions will effectively require
some plans to amend their terms and revise
their materials. For example, the
Departments understand that plans com-
monly require employees to be actively at
work on a designated enrollment day in
order to qualify for enrollment. It is possi-
ble that some plans failed to interpret
HIPAA's statutory provisions to prohibit
this practice. Such plans will need to
amend their terms and materials to provide
that employees will not be denied enroll-
ment solely because they were absent due
to a health status factor. Such plans will
incur administrative costs.

The Departments have no basis for esti-
mating how many plans might need to
implement amendments beyond those
implemented in response to the HIPAA's
statutory nondiscrimination provisions in
order to comply with the regulation's cor-
responding provisions. They adopted con-
servative assumptions in order to develop
an upper bound estimate of the cost to
amend plans and materials to conform
with the regulation. They assumed that all
plans will require at least some amend-
ment to conform with this regulation.

A large majority of fully insured plans
do not have unique eligibility and

employee premium provisions but instead
choose from a relatively small menu of
standardized products offered by issuers.
The Departments accordingly assumed
that issuers will amend their standardized
group insurance products, passing the
associated cost back to the plans that buy
them. They estimate that a total of
approximately 33,000 group insurance
products will be so amended, and that the
cost of these amendments will be spread
across a universe of approximately 2.6
million fully insured plans. The
Departments assumed that small self-
insured plans (which generally fall out-
side state regulation of insurance prod-
ucts) choose from a much larger menu of
products and that large self-insured plans
each have unique eligibility rules will
need to be amended independently. This
implies a total of approximately 76,000
self-insured plan configurations requiring
amendment.

Assuming that each affected group
insurance product and self-insured plan
configuration would require 1 hour of
professional time billed at $72 per hour to
design and implement amendments, the
aggregate cost to amend plans would be
$8 million.

Separate from the cost to design and
implement plan amendments is the cost to
revise plan materials to reflect the amend-
ments. The Departments note that the
cost to revise plan materials can generally
be attributed to legal requirements other
than the HIPAA statute or this regulation.
It is the policy of the Department of Labor
to attribute the cost of revising private-
sector group health plan materials to its
regulation implementing ERISA's
Summary Plan Description requirements.

Various state laws compel issuers to pro-
vide accurate materials, and the
Departments believe that State and local
governmental plan sponsors and private
plan sponsors routinely update plan mate-
rials as a matter of either law or compen-
sation and employment policy.

Notifying Employees of Enrollment
Opportunities - In estimating the costs
associated with the notification require-
ments, the Departments separately con-
sidered the cost of preparing notices and
the cost of distributing them.

Based on a 1993 Robert Wood Johnson
Foundation survey of employers, the
Departments estimate that 128,000 group
health plans excluded individuals on the
basis of health status factors prior to
HIPAA's enactment and will therefore be
required by the regulation to prepare and
distribute notices. The Departments
assumed that preparing the notice will
require one hour of time billed at a $72
hourly rate. The cost to develop notices is
therefore estimated to be $9 million.

The Departments assumed that plans
will distribute notices to all individuals
who are eligible for coverage under the
plan. It might be necessary to notify indi-
viduals who are currently enrolled
because such individuals may have
dependents for whom eligibility was
denied based on a health status factor or
may have failed to enroll dependents
because they expected that eligibility
would be so denied for them. This
assumption probably results in an overes-
timate of the true cost. Some affected
plans may already have notified affected
individuals of their right to enroll under
HIPAA. Others may have historical
records of plan enrollment that are suffi-

ciently detailed to allow for the notifica-
tion of only specific individuals. Based
on the 1997 Robert Wood Johnson
Foundation survey, the Departments esti-
mate that a total of 2.3 million employees
are eligible for coverage under the
128,000 plans that are required to provide
notices. The Departments assumed that
distributing each notice costs $0.37 for
mailing and materials plus 2 minutes of
photocopying and mailing billed at a $15
per hour clerical rate for a total per-notice
distribution cost of $0.87. The cost to dis-
tribute notices is therefore estimated to be
$2 million.

The estimated combined cost to prepare
and distribute notices therefore amounts
to $11 million. The Departments note that
this is a one-time cost which will be
incurred concurrent with the regulation's
applicability date.

The Department's note that the provi-
sion of notices will benefit employees
who newly learn of opportunities to enroll
themselves or their dependents. The
result will be fuller realization of HIPAA's
intent and employees' associated rights, as
well as improved access to affordable
group coverage and reduced rates of unin-
surance for affected employees.

### 4. Summary of Cost Estimates

The cost estimates presented here are
compiled in the table below. Upper bound
cost estimates attributable to the regula-
tion include $8 million to amend plans
and revise documents and $11 million to
prepare and distribute notices of enroll-
ment opportunities, or a total of $19 mil-
lion.

Source of cost

$MM

Explanatory notes

Amending plans and revising materials

Upper bound of new economic cost incurred as plans are amended to comply with the regulation. One-time cost.

Notifying employees of enrollment opportunities

$11

Upper bound of new economic cost to prepare and distribute notices. One-time cost.

Prohibiting discrimination

&gt;$400

Transfer attributable to HIPAA's statutory nondiscriminatory provisions. Transfers attrib- utable to the regulation were not estimated but are expected to be a very small fraction of this amount. Ongoing annual level.

## 5. Assessment of Likelihood of Adverse Secondary Effects

The Departments considered whether
employers might reduce or eliminate health
insurance benefits for all employees as a
result of this regulation. They believe that
this is highly unlikely because the regulation
affirms and clarifies plan sponsors' flexibil-
ity and because its costs will be very small
relative to group health plan expenditures.

The regulation affirms plan sponsors'
flexibility to design plans and control plan
costs in many ways. It affirms and clari-
fies plans' flexibility under HIPAA to
exclude from coverage or limit coverage
for certain conditions or services, to
require employees to perform services
before coverage becomes effective, and to
provide different benefits or charge differ-
ent premiums for employees in different
bona fide employment classes. It also
clarifies that more favorable treatment of
individuals with adverse health factors is
permitted, thereby allowing employers to
assist employees and their families deal-
ing with disabilities, medical conditions,
or other health factors by extending cov-
erage or lowering premiums.

Both the transfer of health insurance
costs and the administrative costs generat-
ed by this regulation will be very small
relative to total group health plan expen-
ditures. The $19 million economic cost
estimate attributed to this regulation
amounts to a tiny fraction of one percent
of the $431 billion that group health plans
will spend this year. Even the more than
$400 million transfer of cost attributed to
HIPAA's statutory nondiscrimination pro-
visions amount to a very small fraction of
one percent of that spending. Plan spon-
sors wishing to do so generally can pass
these costs back to participants with
small, across the board changes to
employee premiums or benefits.

## Statutory Authority

The Department of the Treasury final
and temporary rules are adopted pursuant
to the authority contained in sections 7805
and 9833 of the Code (26 U.S.C. 7805,
9833).

The Department of Labor interim final
rule is adopted pursuant to the authority
contained in sections 107, 209, 505,
701-703, 711-713, and 731-734 of
ERISA (29 U.S.C. 1027, 1059, 1135,

1171-1173, 1181, 1182, and 1191-1194),
as amended by HIPAA (Public Law
104-191, 110 Stat. 1936), MHPA and
NMHPA (Public Law 104-204, 110 Stat.
2935), and WHCRA (Public Law
105-277, 112 Stat. 2681-436), section
101(g)(4) of HIPAA, and Secretary of
Labor's Order No. 1-87, 52 FR 13139,
April 21, 1987.

The Department of HHS interim final
rule is adopted pursuant to the authority
contained in sections 2701 through 2763,
2791, and 2792 of the PHS Act (42 U.S.C.
300gg through 300gg-63, 300gg-91, and
300gg-92), as amended by HIPAA (Public
Law 104-191, 110 Stat. 1936), MHPA and
NMHPA (Public Law 104-204, 110 Stat.
2935), and WHCRA (Public Law 105-277,
112 Stat. 2681-436).
*
*

\*
\*
\*

### Adoption of Amendments to the Regulations

Internal Revenue Service
26 CFR Chapter I

Accordingly, 26 CFR Part 54 is amend-
ed as follows:

#### PART 54 - PENSION EXCISE TAXES

Paragraph 1. The authority citation for
part 54 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 54.9802-1T is
removed.

Par. 3. Section 54.9802-1 is added to
read as follows:

§54.9802-1 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

(a) Health factors. (1) The term
health factor means, in relation to an indi-
vidual, any of the following health status-
related factors:

(i) Health status;

(ii) Medical condition (including both
physical and mental illnesses);

(iii) Claims experience;

(iv) Receipt of health care;

(v) Medical history;

(vi) Genetic information;

(vii) Evidence of insurability; or

(viii) Disability.

(2) Evidence of insurability includes -

(i) Conditions arising out of acts of
domestic violence; and

(ii) [Reserved] For further guidance,
see §54.9802-1T(a)(2)(ii).

(b) Prohibited discrimination in rules
for eligibility - (1) In general - (i) A
group health plan may not establish any
rule for eligibility (including continued
eligibility) of any individual to enroll for
benefits under the terms of the plan that
discriminates based on any health factor
that relates to that individual or a depen-
dent of that individual. This rule is sub-
ject to the provisions of paragraph (b)(2)
of this section (explaining how this rule
applies to benefits), paragraph (b)(3) of
this section (allowing plans to impose cer-
tain preexisting condition exclusions),
paragraph (d) of this section (containing
rules for establishing groups of similarly
situated individuals), paragraph (e) of this
section (relating to nonconfinement,
actively-at-work, and other service
requirements), paragraph (f) of this sec-
tion (relating to bona fide wellness pro-
grams), and paragraph (g) of this section
(permitting favorable treatment of indi-
viduals with adverse health factors).

(ii) [Reserved] For further guidance,
see §54.9802-1T(b)(1)(ii).

(iii) The rules of this paragraph (b)(1)
are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a
group health plan that is available to all employees
who enroll within the first 30 days of their employ-
ment. However, employees who do not enroll with-
in the first 30 days cannot enroll later unless they
pass a physical examination.

(ii) Conclusion. In this Example 1, the require-
ment to pass a physical examination in order to
enroll in the plan is a rule for eligibility that dis-
criminates based on one or more health factors and
thus violates this paragraph (b)(1).

Example 2. [Reserved]

(2) Application to benefits - (i)
General rule - (A) Under this section, a
group health plan is not required to pro-
vide coverage for any particular benefit to
any group of similarly situated individu-
als.

(B) [Reserved] For further guidance,
see §54.9802-1T(b)(2)(i)(B).

(D) [Reserved] For further guidance,
see §54.9802-1T(b)(2)(i)(D).

(ii) Cost-sharing mechanisms and
wellness programs. A group health plan
with a cost-sharing mechanism (such as a
deductible, copayment, or coinsurance)
that requires a higher payment from an
individual, based on a health factor of that

individual or a dependent of that individ-
ual, than for a similarly situated individual
under the plan (and thus does not apply
uniformly to all similarly situated individ-
uals) does not violate the requirements of
this paragraph (b)(2) if the payment dif-
ferential is based on whether an individual
has complied with the requirements of a
bona fide wellness program.

(iii) Specific rule relating to source-of-
injury exclusions. [Reserved] For further
guidance, see §54.9802-1T(b)(2)(iii).

(3) Relationship to section 9801(a),
(b), and (d). [Reserved] For further
guidance, see §54.9802-1T(b)(3).

(c) Prohibited discrimination in premi-
ums or contributions - (1) In general -
(i) A group health plan may not require an
individual, as a condition of enrollment or
continued enrollment under the plan, to pay
a premium or contribution that is greater
than the premium or contribution for a simi-
larly situated individual (described in para-
graph (d) of this section) enrolled in the plan
based on any health factor that relates to the
individual or a dependent of the individual.

(ii) [Reserved] For further guidance,
see §54.9802-1T(c)(1)(ii).

(2) Rules relating to premium rates -
(i) Group rating based on health factors
not restricted under this section. Nothing
in this section restricts the aggregate
amount that an employer may be charged
for coverage under a group health plan.

(ii) List billing based on a health fac-
tor prohibited. [Reserved] For further
guidance, see §54.9802-1T(c)(2)(ii).

(3) Exception for bona fide wellness
programs. Notwithstanding paragraphs
(c)(1) and (2) of this section, a plan may
establish a premium or contribution dif-
ferential based on whether an individual
has complied with the requirements of a
bona fide wellness program.

(d) Similarly situated individuals.
[Reserved] For further guidance, see
§54.9802-1T(d).

(e) Nonconfinement and actively-at-
work provisions. [Reserved] For further
guidance, see §54.9802-1T(e).

(f) Bona fide wellness programs.
[Reserved]

(g) Benign discrimination permitted.
[Reserved] For further guidance, see
§54.9802-1T(g).

(h) No effect on other laws.
[Reserved] For further guidance, see
§54.9802-1T(h).

(i) Effective dates - (1) Final rules
apply March 9, 2001. This section applies
March 9, 2001.

(2) Cross-reference to temporary rules
applicable for plan years beginning on or
after July 1, 2001. See §54.9802-1T
(i)(2), which makes the rules of that sec-
tion applicable for plan years beginning
on or after July 1, 2001.

(3) Cross-reference to temporary tran-
sitional rules for individuals previously
denied coverage based on a health factor.
See §54.9802-1T(i)(3) for transitional
rules that apply with respect to individuals
previously denied coverage under a group
health plan based on a health factor.

Par. 4. Section 54.9802-1T is added to
read as follows:

§54.9802-1T Prohibiting discrimination
against participants and beneficiaries
based on a health factor (temporary).

(a) Health factors. (1) [Reserved]
For further guidance, see §54.9802-1(a).

(2) Evidence of insurability includes -

(i) [Reserved] For further guidance,
see §54.9802-1(a)(2)(i).

(ii) Participation in activities such as
motorcycling, snowmobiling, all-terrain
vehicle riding, horseback riding, skiing,
and other similar activities.

(3) The decision whether health cover-
age is elected for an individual (including
the time chosen to enroll, such as under
special enrollment or late enrollment) is
not, itself, within the scope of any health
factor. (However, under section 9801(f) a
plan must treat special enrollees the same
as similarly situated individuals who are
enrolled when first eligible.)

(b) Prohibited discrimination in rules
for eligibility - (1) In general - (i)
[Reserved] For further guidance, see
§54.9802-1(b)(1)(i).

(ii) For purposes of this section, rules
for eligibility include, but are not limited
to, rules relating to -

(A) Enrollment;

(B) The effective date of coverage;

(D) Late and special enrollment;

(E) Eligibility for benefit packages
(including rules for individuals to change
their selection among benefit packages);

(F) Benefits (including rules relating to
covered benefits, benefit restrictions, and
cost-sharing mechanisms such as coinsur-
ance, copayments, and deductibles), as

described in paragraphs (b)(2) and (3) of
this section;

(G) Continued eligibility; and

(H) Terminating coverage (including
disenrollment) of any individual under the
plan.

(iii) The rules of this paragraph (b)(1)
are illustrated by the following examples:

Example 1. [Reserved] For further guidance,
see §54.9802-1(b)(1)(iii), Example 1.

Example 2. (i) Facts. Under an employer's
group health plan, employees who enroll during the
first 30 days of employment (and during special
enrollment periods) may choose between two bene-
fit packages: an indemnity option and an HMO
option. However, employees who enroll during late
enrollment are permitted to enroll only in the HMO
option and only if they provide evidence of good
health.

(ii) Conclusion. In this Example 2, the require-
ment to provide evidence of good health in order to
be eligible for late enrollment in the HMO option is
a rule for eligibility that discriminates based on one
or more health factors and thus violates this para-
graph (b)(1). However, if the plan did not require
evidence of good health but limited late enrollees to
the HMO option, the plan's rules for eligibility
would not discriminate based on any health factor,
and thus would not violate this paragraph (b)(1),
because the time an individual chooses to enroll is
not, itself, within the scope of any health factor.

Example 3. (i) Facts. Under an employer's
group health plan, all employees generally may
enroll within the first 30 days of employment.
However, individuals who participate in certain
recreational activities, including motorcycling, are
excluded from coverage.

(ii) Conclusion. In this Example 3, excluding
from the plan individuals who participate in recre-
ational activities, such as motorcycling, is a rule for
eligibility that discriminates based on one more
health factors and thus violates this paragraph (b)(1).

Example 4. (i) Facts. A group health plan
applies for a group health policy offered by an issuer.
As part of the application, the issuer receives health
information about individuals to be covered under
the plan. Individual A is an employee of the employ-
er maintaining the plan. A and A's dependents have
a history of high health claims. Based on the infor-
mation about A and A's dependents, the issuer
excludes A and A's dependents from the group poli-
cy it offers to the employer.

(ii) Conclusion. See Example 4 in 29 CFR
2590.702(b)(1) and 45 CFR 146.121(b)(1) for a con-
clusion that the exclusion by the issuer of A and A's
dependents from coverage is a rule for eligibility
that discriminates based on one or more health fac-
tors and violates rules under 29 CFR 2590.702(b)(1)
and 45 CFR 146.121(b)(1) similar to the rules under
this paragraph (b)(1). (If the employer is a small
employer under 45 CFR 144.103 (generally, an
employer with 50 or fewer employees), the issuer
also may violate 45 CFR 146.150, which requires
issuers to offer all the policies they sell in the small
group market on a guaranteed available basis to all
small employers and to accept every eligible indi-
vidual in every small employer group.) If the plan
provides coverage through this policy and does not

provide equivalent coverage for A and A's depen-
dents through other means, the plan will also violate
this paragraph (b)(1).

(2) Application to benefits - (i)
General rule - (A) [Reserved] For fur-
ther guidance, see §54.9802-1(b)
(2)(i)(A).

(B) However, benefits provided under
a plan must be uniformly available to all
similarly situated individuals (as
described in paragraph (d) of this section).
Likewise, any restriction on a benefit or
benefits must apply uniformly to all simi-
larly situated individuals and must not be
directed at individual participants or ben-
eficiaries based on any health factor of the
participants or beneficiaries (determined
based on all the relevant facts and circum-
stances). Thus, for example, a plan may
limit or exclude benefits in relation to a
specific disease or condition, limit or
exclude benefits for certain types of treat-
ments or drugs, or limit or exclude bene-
fits based on a determination of whether
the benefits are experimental or not med-
ically necessary, but only if the benefit
limitation or exclusion applies uniformly
to all similarly situated individuals and is
not directed at individual participants or
beneficiaries based on any health factor of
the participants or beneficiaries. In addi-
tion, a plan may impose annual, lifetime,
or other limits on benefits and may
require the satisfaction of a deductible,
copayment, coinsurance, or other cost-
sharing requirement in order to obtain a
benefit if the limit or cost-sharing require-
ment applies uniformly to all similarly sit-
uated individuals and is not directed at
individual participants or beneficiaries
based on any health factor of the partici-
pants or beneficiaries. In the case of a
cost-sharing requirement, see also para-
graph (b)(2)(ii) of this section, which per-
mits variances in the application of a cost-
sharing mechanism made available under
a bona fide wellness program. (Whether
any plan provision or practice with
respect to benefits complies with this
paragraph (b)(2)(i) does not affect
whether the provision or practice is per-
mitted under any other provision of the
Code, the Americans with Disabilities
Act, or any other law, whether State or
federal.)

(C) For purposes of this paragraph
(b)(2)(i), a plan amendment applicable to
all individuals in one or more groups of
similarly situated individuals under the

plan and made effective no earlier than the
first day of the first plan year after the
amendment is adopted is not considered
to be directed at any individual partici-
pants or beneficiaries.

(D) The rules of this paragraph
(b)(2)(i) are illustrated by the following
examples:

Example 1. (i) Facts. A group health plan
applies a $500,000 lifetime limit on all benefits to
each participant or beneficiary covered under the
plan. The limit is not directed at individual partici-
pants or beneficiaries.

(ii) Conclusion. In this Example 1, the limit does
not violate this paragraph (b)(2)(i) because $500,000
of benefits are available uniformly to each partici-
pant and beneficiary under the plan and because the
limit is applied uniformly to all participants and ben-
eficiaries and is not directed at individual partici-
pants or beneficiaries.

Example 2. (i) Facts. A group health plan has a
$2 million lifetime limit on all benefits (and no other
lifetime limits) for participants covered under the
plan. Participant B files a claim for the treatment of
AIDS. At the next corporate board meeting of the
plan sponsor, the claim is discussed. Shortly there-
after, the plan is modified to impose a $10,000 life-
time limit on benefits for the treatment of AIDS,
effective before the beginning of the next plan year.

(ii) Conclusion. Under the facts of this Example
2, the plan violates this paragraph (b)(2)(i) because
the plan modification is directed at B based on B's
claim.

Example 3. (i) A group health plan applies for a
group health policy offered by an issuer. Individual
C is covered under the plan and has an adverse
health condition. As part of the application, the
issuer receives health information about the individ-
uals to be covered, including information about C's
adverse health condition. The policy form offered
by the issuer generally provides benefits for the
adverse health condition that C has, but in this case
the issuer offers the plan a policy modified by a rider
that excludes benefits for C for that condition. The
exclusionary rider is made effective the first day of
the next plan year.

(ii) Conclusion. See Example 3 in 29 CFR
2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) for a
conclusion that the issuer violates rules under 29
CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i)
similar to the rules under this paragraph (b)(2)(i)
because the rider excluding benefits for the condi-
tion that C has is directed at C even though it applies
by its terms to all participants and beneficiaries
under the plan.

Example 4. (i) Facts. A group health plan has a
$2,000 lifetime limit for the treatment of temporo-
mandibular joint syndrome (TMJ). The limit is
applied uniformly to all similarly situated individu-
als and is not directed at individual participants or
beneficiaries.

(ii) Conclusion. In this Example 4, the limit does
not violate this paragraph (b)(2)(i) because $2000 of
benefits for the treatment of TMJ are available uni-
formly to all similarly situated individuals and a plan
may limit benefits covered in relation to a specific
disease or condition if the limit applies uniformly to
all similarly situated individuals and is not directed

at individual participants or beneficiaries.

Example 5. (i) Facts. A group health plan
applies a $2 million lifetime limit on all benefits.
However, the $2 million lifetime limit is reduced to
$10,000 for any participant or beneficiary covered
under the plan who has a congenital heart defect.

(ii) Conclusion. In this Example 5, the lower life-
time limit for participants and beneficiaries with a
congenital heart defect violates this paragraph
(b)(2)(i) because benefits under the plan are not uni-
formly available to all similarly situated individuals
and the plan's lifetime limit on benefits does not
apply uniformly to all similarly situated individuals.

Example 6. (i) Facts. A group health plan lim-
its benefits for prescription drugs to those listed on a
drug formulary. The limit is applied uniformly to all
similarly situated individuals and is not directed at
individual participants or beneficiaries.

(ii) Conclusion. In this Example 6, the exclusion
from coverage of drugs not listed on the drug for-
mulary does not violate this paragraph (b)(2)(i)
because benefits for prescription drugs listed on the
formulary are uniformly available to all similarly sit-
uated individuals and because the exclusion of drugs
not listed on the formulary applies uniformly to all
similarly situated individuals and is not directed at
individual participants or beneficiaries.

Example 7. (i) Facts. Under a group health plan,
doctor visits are generally subject to a $250 annual
deductible and 20 percent coinsurance requirement.
However, prenatal doctor visits are not subject to
any deductible or coinsurance requirement. These
rules are applied uniformly to all similarly situated
individuals and are not directed at individual partic-
ipants or beneficiaries.

(ii) Conclusion. In this Example 7, imposing dif-
ferent deductible and coinsurance requirements for
prenatal doctor visits and other visits does not vio-
late this paragraph (b)(2)(i) because a plan may
establish different deductibles or coinsurance
requirements for different services if the deductible
or coinsurance requirement is applied uniformly to
all similarly situated individuals and is not directed
at individual participants or beneficiaries.

(ii) Cost-sharing mechanisms and
wellness programs. [Reserved] For fur-
ther guidance, see §54.9802-1(b)(2)(ii).

(iii) Specific rule relating to source-of-
injury exclusions - (A) If a group health
plan generally provides benefits for a type
of injury, the plan may not deny benefits
otherwise provided for treatment of the
injury if the injury results from an act of
domestic violence or a medical condition
(including both physical and mental
health conditions).

(B) The rules of this paragraph
(b)(2)(iii) are illustrated by the following
examples:

Example 1. (i) Facts. A group health plan gen-
erally provides medical/surgical benefits, including
benefits for hospital stays, that are medically neces-
sary. However, the plan excludes benefits for self-
inflicted injuries or injuries sustained in connection
with attempted suicide. Individual D suffers from
depression and attempts suicide. As a result, D sus-
tains injuries and is hospitalized for treatment of the

injuries. Pursuant to the exclusion, the plan denies D
benefits for treatment of the injuries.

(ii) Conclusion. In this Example 1, the suicide
attempt is the result of a medical condition (depres-
sion). Accordingly, the denial of benefits for the
treatments of D's injuries violates the requirements
of this paragraph (b)(2)(iii) because the plan provi-
sion excludes benefits for treatment of an injury
resulting from a medical condition.

Example 2. (i) Facts. A group health plan pro-
vides benefits for head injuries generally. The plan
also has a general exclusion for any injury sustained
while participating in any of a number of recreational
activities, including bungee jumping. However, this
exclusion does not apply to any injury that results from
a medical condition (nor from domestic violence).
Participant E sustains a head injury while bungee
jumping. The injury did not result from a medical con-
dition (nor from domestic violence). Accordingly, the
plan denies benefits for E's head injury.

(ii) Conclusion. In this Example 2, the plan provi-
sion that denies benefits based on the source of an
injury does not restrict benefits based on an act of
domestic violence or any medical condition.
Therefore, the provision is permissible under this para-
graph (b)(2)(iii) and does not violate this section.
(However, if the plan did not allow E to enroll in the
plan (or applied different rules for eligibility to E)
because E frequently participates in bungee jumping,
the plan would violate paragraph (b)(1) of this sec-
tion.)

(3) Relationship to section 9801(a),
(b), and (d). (i) A preexisting condition
exclusion is permitted under this section if
it -

(A) Complies with section 9801(a),
(b), and (d);

(B) Applies uniformly to all similarly
situated individuals (as described in para-
graph (d) of this section); and

(C) Is not directed at individual partic-
ipants or beneficiaries based on any health
factor of the participants or beneficiaries.
For purposes of this paragraph
(b)(3)(i)(C), a plan amendment relating to
a preexisting condition exclusion applica-
ble to all individuals in one or more
groups of similarly situated individuals
under the plan and made effective no ear-
lier than the first day of the first plan year
after the amendment is adopted is not con-
sidered to be directed at any individual
participants or beneficiaries.

(ii) The rules of this paragraph (b)(3)
are illustrated by the following examples:

Example 1. (i) Facts. A group health plan
imposes a preexisting condition exclusion on all
individuals enrolled in the plan. The exclusion
applies to conditions for which medical advice,
diagnosis, care, or treatment was recommended or
received within the six-month period ending on an
individual's enrollment date. In addition, the
exclusion generally extends for 12 months after an
individual's enrollment date, but this 12-month
period is offset by the number of days of an indi-

vidual's creditable coverage in accordance with
section 9801(a). There is nothing to indicate that
the exclusion is directed at individual participants
or beneficiaries.

(ii) Conclusion. In this Example 1, even though
the plan's preexisting condition exclusion discrimi-
nates against individuals based on one or more
health factors, the preexisting condition exclusion
does not violate this section because it applies uni-
formly to all similarly situated individuals, is not
directed at individual participants or beneficiaries,
and complies with section 9801(a), (b), and (d) (that
is, the requirements relating to the six-month look-
back period, the 12-month (or 18-month) maximum
exclusion period, and the creditable coverage off-
set).

Example 2. (i) Facts. A group health plan
excludes coverage for conditions with respect to
which medical advice, diagnosis, care, or treatment
was recommended or received within the six-month
period ending on an individual's enrollment date.
Under the plan, the preexisting condition exclusion
generally extends for 12 months, offset by creditable
coverage. However, if an individual has no claims in
the first six months following enrollment, the
remainder of the exclusion period is waived.

(ii) Conclusion. In this Example 2, the plan's
preexisting condition exclusions violate this section
because they do not meet the requirements of this
paragraph (b)(3); specifically, they do not apply uni-
formly to all similarly situated individuals. The plan
provisions do not apply uniformly to all similarly sit-
uated individuals because individuals who have
medical claims during the first six months following
enrollment are not treated the same as similarly situ-
ated individuals with no claims during that period.
(Under paragraph (d) of this section, the groups can-
not be treated as two separate groups of similarly sit-
uated individuals because the distinction is based on
a health factor.)

(c) Prohibited discrimination in premi-
ums or contributions - (1) In general-
(i) [Reserved] For further guidance, see
§54.9802-1(c)(1)(i).

(ii) Discounts, rebates, payments in
kind, and any other premium differential
mechanisms are taken into account in
determining an individual's premium or
contribution rate. (For rules relating to
cost-sharing mechanisms, see paragraph
(b)(2) of this section (addressing benefits).)

(2) Rules relating to premium rates -
(i) Group rating based on health factors
not restricted under this section.
[Reserved] For further guidance, see
§54.9802-1(c)(2)(i).

(ii) List billing based on a health fac-
tor prohibited. However, a group health
plan may not quote or charge an employ-
er (or an individual) a different premium
for an individual in a group of similarly
situated individuals based on a health fac-
tor. (But see paragraph (g) of this section
permitting favorable treatment of individ-
uals with adverse health factors.)

(iii) Examples. The rules of this para-
graph (c)(2) are illustrated by the follow-
ing examples:

Example 1. (i) Facts. An employer sponsors a
group health plan and purchases coverage from a
health insurance issuer. In order to determine the
premium rate for the upcoming plan year, the issuer
reviews the claims experience of individuals covered
under the plan. The issuer finds that Individual F
had significantly higher claims experience than sim-
ilarly situated individuals in the plan. The issuer
quotes the plan a higher per-participant rate because
of F's claims experience.

(ii) Conclusion. See Example 1 in 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a con-
clusion that the issuer does not violate the provisions
of 29 CFR 2590.702(c)(2) and 45 CFR
146.121(c)(2) similar to the provisions of this para-
graph (c)(2) because the issuer blends the rate so that
the employer is not quoted a higher rate for F than
for a similarly situated individual based on F's
claims experience.

Example 2. (i) Facts. Same facts as Example 1,
except that the issuer quotes the employer a higher
premium rate for F, because of F's claims experi-
ence, than for a similarly situated individual.

(ii) Conclusion. See Example 2 in 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a con-
clusion that the issuer violates provisions of 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to
the provisions of this paragraph (c)(2). Moreover,
even if the plan purchased the policy based on the
quote but did not require a higher participant contri-
bution for F than for a similarly situated individual,
see Example 2 in 29 CFR 2590.702(c)(2) and 45
CFR 146.121(c)(2) for a conclusion that the issuer
would still violate 29 CFR 2590.702(c)(2) and 45
CFR 146.121(c)(2) (but in such a case the plan
would not violate this paragraph (c)(2)).

(3) Exception for bona fide wellness
programs. [Reserved] For further guid-
ance, see §54.9802-1(c)(3).

(d) Similarly situated individuals. The
requirements of this section apply only
within a group of individuals who are
treated as similarly situated individuals.
A plan may treat participants as a group of
similarly situated individuals separate
from beneficiaries. In addition, partici-
pants may be treated as two or more dis-
tinct groups of similarly situated individu-
als and beneficiaries may be treated as
two or more distinct groups of similarly
situated individuals in accordance with
the rules of this paragraph (d). Moreover,
if individuals have a choice of two or
more benefit packages, individuals choos-
ing one benefit package may be treated as
one or more groups of similarly situated
individuals distinct from individuals
choosing another benefit package.

(1) Participants. Subject to paragraph
(d)(3) of this section, a plan may treat par-
ticipants as two or more distinct groups of

similarly situated individuals if the dis-
tinction between or among the groups of
participants is based on a bona fide
employment-based classification consis-
tent with the employer's usual business
practice. Whether an employment-based
classification is bona fide is determined
on the basis of all the relevant facts and
circumstances. Relevant facts and cir-
cumstances include whether the employer
uses the classification for purposes inde-
pendent of qualification for health cover-
age (for example, determining eligibility
for other employee benefits or determin-
ing other terms of employment). Subject
to paragraph (d)(3) of this section, exam-
ples of classifications that, based on all
the relevant facts and circumstances, may
be bona fide include full-time versus part-
time status, different geographic location,
membership in a collective bargaining
unit, date of hire, length of service, cur-
rent employee versus former employee
status, and different occupations.
However, a classification based on any
health factor is not a bona fide employ-
ment-based classification, unless the
requirements of paragraph (g) of this sec-
tion are satisfied (permitting favorable
treatment of individuals with adverse
health factors).

(2) Beneficiaries - (i) Subject to
paragraph (d)(3) of this section, a plan
may treat beneficiaries as two or more
distinct groups of similarly situated indi-
viduals if the distinction between or
among the groups of beneficiaries is
based on any of the following factors:

(A) A bona fide employment-based
classification of the participant through
whom the beneficiary is receiving cover-
age;

(B) Relationship to the participant
(e.g., as a spouse or as a dependent child);

(D) With respect to children of a par-
ticipant, age or student status; or

(E) Any other factor if the factor is not
a health factor.

(ii) Paragraph (d)(2)(i) of this section
does not prevent more favorable treatment
of beneficiaries with adverse health fac-
tors in accordance with paragraph (g) of
this section.

(3) Discrimination directed at individ-
uals. Notwithstanding paragraphs (d)(1)
and (2) of this section, if the creation or
modification of an employment or cover-

age classification is directed at individual
participants or beneficiaries based on any
health factor of the participants or benefi-
ciaries, the classification is not permitted
under this paragraph (d), unless it is per-
mitted under paragraph (g) of this section
(permitting favorable treatment of indi-
viduals with adverse health factors).
Thus, if an employer modified an employ-
ment-based classification to single out,
based on a health factor, individual partic-
ipants and beneficiaries and deny them
health coverage, the new classification
would not be permitted under this section.

(4) Examples. The rules of this para-
graph (d) are illustrated by the following
examples:

Example 1. (i) Facts. An employer sponsors a
group health plan for full-time employees only.
Under the plan (consistent with the employer's
ususal business practice), employees who normally
work at least 30 hours per week are considered to be
working full-time. Other employees are considered
to be working part-time. There is no evidence to
suggest that the classification is directed at individ-
ual participants or beneficiaries.

(ii) Conclusion. In this Example 1, treating the
full-time and part-time employees as two separate
groups of similarly situated individuals is permitted
under this paragraph (d) because the classification is
bona fide and is not directed at individual partici-
pants or beneficiaries.

Example 2. (i) Facts. Under a group health plan,
coverage is made available to employees, their
spouses, and their dependent children. However,
coverage is made available to a dependent child
only if the dependent child is under age 19 (or under
age 25 if the child is continuously enrolled full-time
in an institution of higher learning (full-time stu-
dents). There is no evidence to suggest that these
classifications are directed at individual participants
or beneficiaries.

(ii) Conclusion. In this Example 2, treating
spouses and dependent children differently by
imposing an age limitation on dependent children,
but not on spouses, is permitted under this paragraph
(d). Specifically, the distinction between spouses and
dependent children is permitted under paragraph (d)(2)
of this section and is not prohibited under paragraph
(d)(3) of this section because it is not directed at indi-
vidual participants or beneficiaries. It is also permissi-
ble to treat dependent children who are under age 19
(or full-time students under age 25) as a group of sim-
ilarly situated individuals separate from those who are
age 25 or older (or age 19 or older if they are not full-
time students) because the classification is permitted
under paragraph (d)(2) of this section and is not direct-
ed at individual participants or beneficiaries.

Example 3. (i) Facts. A university sponsors a
group health plan that provides one health benefit
package to faculty and another health benefit pack-
age to other staff. Faculty and staff are treated dif-
ferently with respect to other employee benefits such
as retirement benefits and leaves of absence. There
is no evidence to suggest that the distinction is
directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 3, the classifi-
cation is permitted under this paragraph (d) because
there is a distinction based on a bona fide employ-
ment-based classification consistent with the
employer's usual business practice and the distinc-
tion is not directed at individual participants and
beneficiaries.

Example 4. (i) Facts. An employer sponsors a
group health plan that is available to all current
employees. Former employees may also be eligible,
but only if they complete a specified number of
years of service, are enrolled under the plan at the
time of termination of employment, and are continu-
ously enrolled from that date. There is no evidence
to suggest that these distinctions are directed at indi-
vidual participants or beneficiaries.

(ii) Conclusion. In this Example 4, imposing
additional eligibility requirements on former employ-
ees is permitted because a classification that distin-
guishes between current and former employees is a
bona fide employment-based classification that is
permitted under this paragraph (d), provided that it is
not directed at individual participants or beneficia-
ries. In addition, it is permissible to distinguish
between former employees who satisfy the service
requirement and those who do not, provided that the
distinction is not directed at individual participants or
beneficiaries. (However, former employees who do
not satisfy the eligibility criteria may, nonetheless, be
eligible for continued coverage pursuant to a
COBRA continuation provision or similar State law.)

Example 5. (i) Facts. An employer sponsors a
group health plan that provides the same benefit
package to all seven employees of the employer. Six
of the seven employees have the same job title and
responsibilities, but Employee G has a different job
title and different responsibilities. After G files an
expensive claim for benefits under the plan, cover-
age under the plan is modified so that employees
with G's job title receive a different benefit package
that includes a lower lifetime dollar limit than in the
benefit package made available to the other six
employees.

(ii) Conclusion. Under the facts of this Example
5, changing the coverage classification for G based
on the existing employment classification for G is
not permitted under this paragraph (d) because the
creation of the new coverage classification for G is
directed at G based on one or more health factors.

(e) Nonconfinement and actively-at-
work provisions - (1) Nonconfinement
provisions - (i) General rule. Under the
rules of paragraphs (b) and (c) of this sec-
tion, a plan may not establish a rule for
eligibility (as described in paragraph
(b)(1)(ii) of this section) or set any indi-
vidual's premium or contribution rate
based on whether an individual is con-
fined to a hospital or other health care
institution. In addition, under the rules of
paragraphs (b) and (c) of this section, a
plan may not establish a rule for eligibili-
ty or set any individual's premium or con-
tribution rate based on an individual's
ability to engage in normal life activities,
except to the extent permitted under para-

graphs (e)(2)(ii) and (3) of this section
(permitting plans, under certain circum-
stances, to distinguish among employees
based on the performance of services).

(ii) Examples. The rules of this para-
graph (e)(1) are illustrated by the follow-
ing examples:

Example 1. (i) Facts. Under a group health plan,
coverage for employees and their dependents gener-
ally becomes effective on the first day of employ-
ment. However, coverage for a dependent who is
confined to a hospital or other health care institution
does not become effective until the confinement
ends.

(ii) Conclusion. In this Example 1, the plan vio-
lates this paragraph (e)(1) because the plan delays
the effective date of coverage for dependents based
on confinement to a hospital or other health care
institution.

Example 2. (i) Facts. In previous years, a group
health plan has provided coverage through a group
health insurance policy offered by Issuer M.
However, for the current year, the plan provides cov-
erage through a group health insurance policy
offered by Issuer N. Under Issuer N's policy, items
and services provided in connection with the con-
finement of a dependent to a hospital or other health
care institution are not covered if the confinement is
covered under an extension of benefits clause from a
previous health insurance issuer.

(ii) Conclusion. See Example 2 in 29 CFR
2590.702(e)(1) and 45 CFR 146.121(e)(1) for a con-
clusion that Issuer N violates provisions of 29 CFR
2590.702(e)(1) and 45 CFR 146.121(e)(1) similar to
the provisions of this paragraph (e)(1) because Issuer
N restricts benefits based on whether a dependent is
confined to a hospital or other health care institution
that is covered under an extension of benefits from a
previous issuer.

(2) Actively-at-work and continuous
service provisions - (i) General rule -
(A) Under the rules of paragraphs (b) and
(c) of this section and subject to the
exception for the first day of work in para-
graph (e)(2)(ii) of this section, a plan may
not establish a rule for eligibility (as
described in paragraph (b)(1)(ii) of this
section) or set any individual's premium
or contribution rate based on whether an
individual is actively at work (including
whether an individual is continuously
employed), unless absence from work due
to any health factor (such as being absent
from work on sick leave) is treated, for
purposes of the plan, as being actively at
work.

(B) The rules of this paragraph (e)(2)(i)
are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan,
an employee generally becomes eligible to enroll 30
days after the first day of employment. However, if
the employee is not actively at work on the first day
after the end of the 30-day period, then eligibility for
enrollment is delayed until the first day the employ-
ee is actively at work.

(ii) Conclusion. In this Example 1, the plan vio-
lates this paragraph (e)(2) (and thus also violates
paragraph (b) of this section). However, the plan
would not violate paragraph (e)(2) or (b) of this sec-
tion if, under the plan, an absence due to any health
factor is considered being actively at work.

Example 2. (i) Facts. Under a group health plan,
coverage for an employee becomes effective after 90
days of continuous service; that is, if an employee is
absent from work (for any reason) before completing
90 days of service, the beginning of the 90-day peri-
od is measured from the day the employee returns to
work (without any credit for service before the
absence).

(ii) Conclusion. In this Example 2, the plan vio-
lates this paragraph (e)(2) (and thus also paragraph
(b) of this section) because the 90-day continuous
service requirement is a rule for eligibility based on
whether an individual is actively at work. However,
the plan would not violate this paragraph (e)(2) or
paragraph (b) of this section if, under the plan, an
absence due to any health factor is not considered an
absence for purposes of measuring 90 days of con-
tinuous service.

(ii) Exception for the first day of work
\- (A) Notwithstanding the general rule
in paragraph (e)(2)(i) of this section, a
plan may establish a rule for eligibility
that requires an individual to begin work
for the employer sponsoring the plan (or,
in the case of a multiemployer plan, to
begin a job in covered employment)
before coverage becomes effective, pro-
vided that such a rule for eligibility
applies regardless of the reason for the
absence.

(B) The rules of this paragraph
(e)(2)(ii) are illustrated by the following
examples:

Example 1. (i) Facts. Under the eligibility pro-
vision of a group health plan, coverage for new
employees becomes effective on the first day that the
employee reports to work. Individual H is scheduled
to begin work on August 3. However, H is unable to
begin work on that day because of illness. H begins
working on August 4, and H's coverage is effective
on August 4.

(ii) Conclusion. In this Example 1, the plan pro-
vision does not violate this section. However, if cov-
erage for individuals who do not report to work on
the first day they were scheduled to work for a rea-
son unrelated to a health factor (such as vacation or
bereavement) becomes effective on the first day they
were scheduled to work, then the plan would violate
this section.

Example 2. (i) Facts. Under a group health
plan, coverage for new employees becomes effec-
tive on the first day of the month following the
employee's first day of work, regardless of
whether the employee is actively at work on the
first day of the month. Individual J is scheduled to
begin work on March 24. However, J is unable to
begin work on March 24 because of illness. J
begins working on April 7 and J's coverage is
effective May 1.

(ii) Conclusion. In this Example 2, the plan pro-
vision does not violate this section. However, as in

Example 1, if coverage for individuals absent from
work for reasons unrelated to a health factor became
effective despite their absence, then the plan would
violate this section.

(3) Relationship to plan provisions
defining similarly situated individuals -
(i) Notwithstanding the rules of para-
graphs (e)(1) and (2) of this section, a
plan may establish rules for eligibility or
set any individual's premium or contri-
bution rate in accordance with the rules
relating to similarly situated individuals
in paragraph (d) of this section.
Accordingly, a plan may distinguish in
rules for eligibility under the plan
between full-time and part-time employ-
ees, between permanent and temporary
or seasonal employees, between current
and former employees, and between
employees currently performing services
and employees no longer performing ser-
vices for the employer, subject to para-
graph (d) of this section. However, other
federal or State laws (including the
COBRA continuation provisions and the
Family and Medical Leave Act of 1993)
may require an employee or the employ-
ee's dependents to be offered coverage
and set limits on the premium or contri-
bution rate even though the employee is
not performing services.

(ii) The rules of this paragraph (e)(3)
are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan,
employees are eligible for coverage if they perform
services for the employer for 30 or more hours per
week or if they are on paid leave (such as annual,
sick, or bereavement leave). Employees on unpaid
leave are treated as a separate group of similarly sit-
uated individuals in accordance with the rules of
paragraph (d) of this section.

(ii) Conclusion. In this Example 1, the plan pro-
visions do not violate this section. However, if the
plan treated individuals performing services for the
employer for 30 or more hours per week, individuals
on annual leave, and individuals on bereavement
leave as a group of similarly situated individuals
separate from individuals on sick leave, the plan
would violate this paragraph (e) (and thus also
would violate paragraph (b) of this section) because
groups of similarly situated individuals cannot be
established based on a health factor (including the
taking of sick leave) under paragraph (d) of this sec-
tion.

Example 2. (i) Facts. To be eligible for cover-
age under a bona fide collectively bargained group
health plan in the current calendar quarter, the plan
requires an individual to have worked 250 hours in
covered employment during the three-month period
that ends one month before the beginning of the cur-
rent calendar quarter. The distinction between
employees working at least 250 hours and those
working less than 250 hours in the earlier three-
month period is not directed at individual partici-

pants or beneficiaries based on any health factor of
the participants or beneficiaries.

(ii) Conclusion. In this Example 2, the plan pro-
vision does not violate this section because, under
the rules for similarly situated individuals allowing
full-time employees to be treated differently than
part-time employees, employees who work at least
250 hours in a three-month period can be treated dif-
ferently than employees who fail to work 250 hours
in that period. The result would be the same if the
plan permitted individuals to apply excess hours
from previous periods to satisfy the requirement for
the current quarter.

Example 3. (i) Facts. Under a group health plan,
coverage of an employee is terminated when the
individual's employment is terminated, in accor-
dance with the rules of paragraph (d) of this section.
Employee B has been covered under the plan. B
experiences a disabling illness that prevents B from
working. B takes a leave of absence under the
Family and Medical Leave Act of 1993. At the end
of such leave, B terminates employment and conse-
quently loses coverage under the plan. (This termi-
nation of coverage is without regard to whatever
rights the employee (or members of the employee's
family) may have for COBRA continuation cover-
age.)

(ii) Conclusion. In this Example 3, the plan pro-
vision terminating B's coverage upon B's termina-
tion of employment does not violate this section.

Example 4. (i) Facts. Under a group health plan,
coverage of an employee is terminated when the
employee ceases to perform services for the employ-
er sponsoring the plan, in accordance with the rules
of paragraph (d) of this section. Employee C is laid
off for three months. When the layoff begins, C's
coverage under the plan is terminated. (This termi-
nation of coverage is without regard to whatever
rights the employee (or members of the employee's
family) may have for COBRA continuation cover-
age.)

(ii) Conclusion. In this Example 4, the plan pro-
vision terminating C's coverage upon the cessation
of C's performance of services does not violate this
section.

(f) Bona fide wellness programs.
[Reserved]

(g) More favorable treatment of indi-
viduals with adverse health factors per-
mitted - (1) In rules for eligibility - (i)
Nothing in this section prevents a group
health plan from establishing more
favorable rules for eligibility (described
in paragraph (b)(1) of this section) for
individuals with an adverse health factor,
such as disability, than for individuals
without the adverse health factor.
Moreover, nothing in this section pre-
vents a plan from charging a higher pre-
mium or contribution with respect to
individuals with an adverse health factor
if they would not be eligible for the cov-
erage were it not for the adverse health
factor. (However, other laws, including
State insurance laws, may set or limit

premium rates; these laws are not affect-
ed by this section.)

(ii) The rules of this paragraph (g)(1)
are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a
group health plan that generally is available to
employees, spouses of employees, and dependent
children until age 23. However, dependent children
who are disabled are eligible for coverage beyond
age 23.

(ii) Conclusion. In this Example 1, the plan pro-
vision allowing coverage for disabled dependent
children beyond age 23 satisfies this paragraph
(g)(1) (and thus does not violate this section).

Example 2. (i) Facts. An employer sponsors a
group health plan, which is generally available to
employees (and members of the employee's family)
until the last day of the month in which the employ-
ee ceases to perform services for the employer. The
plan generally charges employees $50 per month for
employee-only coverage and $125 per month for
family coverage. However, an employee who ceas-
es to perform services for the employer by reason of
disability may remain covered under the plan until
the last day of the month that is 12 months after the
month in which the employee ceased to perform ser-
vices for the employer. During this extended period
of coverage, the plan charges the employee $100 per
month for employee-only coverage and $250 per
month for family coverage. (This extended period of
coverage is without regard to whatever rights the
employee (or members of the employee's family)
may have for COBRA continuation coverage.)

(ii) Conclusion. In this Example 2, the plan pro-
vision allowing extended coverage for disabled
employees and their families satisfies this paragraph
(g)(1) (and thus does not violate this section). In
addition, the plan is permitted, under this paragraph
(g)(1), to charge the disabled employees a higher
premium during the extended period of coverage.

Example 3. (i) Facts. To comply with the
requirements of a COBRA continuation provision, a
group health plan generally makes COBRA continu-
ation coverage available for a maximum period of 18
months in connection with a termination of employ-
ment but makes the coverage available for a maxi-
mum period of 29 months to certain disabled indi-
viduals and certain members of the disabled
individual's family. Although the plan generally
requires payment of 102 percent of the applicable
premium for the first 18 months of COBRA contin-
uation coverage, the plan requires payment of 150
percent of the applicable premium for the disabled
individual's COBRA continuation coverage during
the disability extension if the disabled individual
would not be entitled to COBRA continuation cov-
erage but for the disability.

(ii) Conclusion. In this Example 3, the plan
provision allowing extended COBRA continuation
coverage for disabled individuals satisfies this
paragraph (g)(1) (and thus does not violate this
section). In addition, the plan is permitted, under
this paragraph (g)(1), to charge the disabled indi-
viduals a higher premium for the extended cover-
age if the individuals would not be eligible for
COBRA continuation coverage were it not for the
disability. (Similarly, if the plan provided an
extended period of coverage for disabled individu-

als pursuant to State law or plan provision rather
than pursuant to a COBRA continuation coverage
provision, the plan could likewise charge the dis-
abled individuals a higher premium for the extend-
ed coverage.)

(2) In premiums or contributions - (i)
Nothing in this section prevents a group
health plan from charging individuals a
premium or contribution that is less than
the premium (or contribution) for similar-
ly situated individuals if the lower charge
is based on an adverse health factor, such
as disability.

(ii) The rules of this paragraph (g)(2)
are illustrated by the following example:

Example. (i) Facts. Under a group health plan,
employees are generally required to pay $50 per
month for employee-only coverage and $125 per
month for family coverage under the plan. However,
employees who are disabled receive coverage
(whether employee-only or family coverage) under
the plan free of charge.

(ii) Conclusion. In this Example, the plan provi-
sion waiving premium payment for disabled
employees is permitted under this paragraph (g)(2)
(and thus does not violate this section).

(h) No effect on other laws.
Compliance with this section is not
determinative of compliance with any
other provision of the Code (including
the COBRA continuation provisions) or
any other State or federal law, such as
the Americans with Disabilities Act.
Therefore, although the rules of this sec-
tion would not prohibit a plan or issuer
from treating one group of similarly sit-
uated individuals differently from anoth-
er (such as providing different benefit
packages to current and former employ-
ees), other federal or State laws may
require that two separate groups of sim-
ilarly situated individuals be treated the
same for certain purposes (such as mak-
ing the same benefit package available
to COBRA qualified beneficiaries as is
made available to active employees). In
addition, although this section generally
does not impose new disclosure obliga-
tions on plans, this section does not
affect any other laws, including those
that require accurate disclosures and
prohibit intentional misrepresentation.

(i) Effective dates - (1) Final rules
apply March 9, 2001. [Reserved] For
further guidance, see §54.9802-1(i)(1).

(2) This section applies for plan years
beginning on or after July 1, 2001.
Except as provided in paragraph (i)(3) of
this section, this section applies for plan
years beginning on or after July 1, 2001.

Except as provided in paragraph (i)(3) of
this section, with respect to efforts to com-
ply with section 9802 before the first plan
year beginning on or after July 1, 2001,
the Secretary will not take any enforce-
ment action against a plan that has sought
to comply in good faith with section 9802.

(3) Transitional rules for individuals
previously denied coverage based on a
health factor. This paragraph (i)(3) pro-
vides rules relating to individuals previ-
ously denied coverage under a group
health plan based on a health factor of the
individual. Paragraph (i)(3)(i) clarifies
what constitutes a denial of coverage
under this paragraph (i)(3). Paragraph
(i)(3)(ii) of this section applies with
respect to any individual who was denied
coverage if the denial was not based on a
good faith interpretation of section 9802
or the Secretary's published guidance.
Under that paragraph, such an individual
must be allowed to enroll retroactively to
the effective date of section 9802, or, if
later, the date the individual meets eligi-
bility criteria under the plan that do not
discriminate based on any health factor.
Paragraph (i)(3)(iii) of this section
applies with respect to any individual
who was denied coverage based on a
good faith interpretation of section 9802
or the Secretary's published guidance.
Under that paragraph, such an individual
must be given an opportunity to enroll
effective July 1, 2001. In either event,
whether under paragraph (i)(3)(ii) or (iii)
of this section, the Secretary will not take
any enforcement action with respect to
denials of coverage addressed in this
paragraph (i)(3) if the plan has complied
with the transitional rules of this para-
graph (i)(3).

(i) Denial of coverage clarified. For
purposes of this paragraph (i)(3), an indi-
vidual is considered to have been denied
coverage if the individual -

(A) Failed to apply for coverage
because it was reasonable to believe that
an application for coverage would have
been futile due to a plan provision that
discriminated based on a health factor; or

(B) Was not offered an opportunity to
enroll in the plan and the failure to give
such an opportunity violates this section.

(ii) Individuals denied coverage with-
out a good faith interpretation of the law
\- (A) Opportunity to enroll required. If
a plan has denied coverage to any indi-

vidual based on a health factor and that
denial was not based on a good faith
interpretation of section 9802 or any
guidance published by the Secretary, the
plan is required to give the individual an
opportunity to enroll (including notice of
an opportunity to enroll) that continues
for at least 30 days. This opportunity
must be presented not later than March 9,
2001.

(1) If this enrollment opportunity was
presented before or within the first plan
year beginning on or after July 1, 1997 (or
in the case of a collectively bargained
plan, before or within the first plan year
beginning on the effective date for the
plan described in section 401(c)(3) of the
Health Insurance Portability and
Accountability Act of 1996), the coverage
must be effective within that first plan
year.

(2) If this enrollment opportunity is
presented after such plan year, the indi-
vidual must be given the choice of having
the coverage effective on either of the fol-
lowing two dates -

(i) The date the plan receives a request
for enrollment in connection with the
enrollment opportunity; or

(ii) Retroactively to the first day of the
first plan year beginning on the effective
date for the plan described in section
401(c)(1) or (3) of the Health Insurance
Portability and Accountability Act of 1996
(or, if the individual otherwise first
became eligible to enroll for coverage
after that date, on the date the individual
was otherwise eligible to enroll in the
plan). If an individual elects retroactive
coverage, the plan is required to provide
the benefits it would have provided if the
individual had been enrolled for coverage
during that period (irrespective of any oth-
erwise applicable plan provisions govern-
ing timing for the submission of claims).
The plan may require the individual to pay
whatever additional amount the individual
would have been required to pay for the
coverage (but the plan cannot charge
interest on that amount).

(B) Relation to preexisting condition
rules. For purposes of Chapter 100 of
Subtitle K, the individual may not be
treated as a late enrollee or as a special
enrollee. Moreover, the individual's
enrollment date is the effective date for
the plan described in section 401(c)(1) or
(3) of the Health Insurance Portability and

Accountability Act of 1996 (or, if the indi-
vidual otherwise first became eligible to
enroll for coverage after that date, on the
date the individual was otherwise eligible
to enroll in the plan), even if the individ-
ual chooses under paragraph (i)(3)(ii)(A)
of this section to have coverage effective
only prospectively. In addition, any peri-
od between the individual's enrollment
date and the effective date of coverage is
treated as a waiting period.

Example 1. (i) Facts. Employer X maintains a
group health plan with a plan year beginning
October 1 and ending September 30. Individual F
was hired by Employer X before the effective date
of section 9802. Before the effective date of sec-
tion 9802 for this plan (October 1, 1997), the terms
of the plan allowed employees and their dependents
to enroll when the employee was first hired, and on
each January 1 thereafter, but in either case, only if
the individual could pass a physical examination.
F's application to enroll when first hired was
denied because F could not pass a physical exami-
nation. Upon the effective date of section 9802 for
this plan (October 1, 1997), the plan is amended to
delete the requirement to pass a physical examina-
tion. In November of 1997, the plan gives F an
opportunity to enroll in the plan (including notice
of the opportunity to enroll) without passing a
physical examination, with coverage effective
January 1, 1998.

(ii) Conclusion. In this Example 1, the plan com-
plies with the requirements of this paragraph (i)(3)(ii).

Example 2. (i) Facts. The plan year of a group
health plan begins January 1 and ends December 31.
Under the plan, a dependent who is unable to engage
in normal life activities on the date coverage would
otherwise become effective is not enrolled until the
dependent is able to engage in normal life activities.
Individual G is a dependent who is otherwise eligi-
ble for coverage, but is unable to engage in normal
life activities. The plan has not allowed G to enroll
for coverage.

(ii) Conclusion. In this Example 2, beginning on
the effective date of section 9802 for the plan
(January 1, 1998), the plan provision is not permitted
under any good faith interpretation of section 9802
or any guidance published by the Secretary.
Therefore, the plan is required, not later than March
9, 2001, to give G an opportunity to enroll (including
notice of the opportunity to enroll), with coverage
effective, at G's option, either retroactively from
January 1, 1998 or prospectively from the date G's
request for enrollment is received by the plan. If G
elects coverage to be effective beginning January 1,
1998, the plan can require G to pay employee premi-
ums for the retroactive coverage.

(iii) Individuals denied coverage
based on a good faith interpretation of
the law - (A) Opportunity to enroll
required. If a plan has denied coverage
to any individual before the first day of
the first plan year beginning on or after

July 1, 2001 based in part on a health fac-
tor and that denial was based on a good
faith interpretation of section 9802 or
guidance published by the Secretary, the
plan is required to give the individual an
opportunity to enroll (including notice of
an opportunity to enroll) that continues
for at least 30 days, with coverage effec-
tive no later than July 1, 2001.
Individuals required to be offered an
opportunity to enroll include individuals
previously offered enrollment without
regard to a health factor but subsequent-
ly denied enrollment due to a health fac-
tor.

(B) Relation to preexisting condition
rules. For purposes of Chapter 100 of
Subtitle K, the individual may not be treat-
ed as a late enrollee or as a special enrollee.
Moreover, the individual's enrollment date
under the plan is the effective date for the
plan described in section 401(c)(1) or (3) of
the Health Insurance Portability and
Accountability Act of 1996 (or, if the indi-
vidual otherwise first became eligible to
enroll for coverage after that date, on the
date the individual was otherwise eligible
to enroll in the plan). In addition, any peri-
od between the individual's enrollment
date and the effective date of coverage is
treated as a waiting period.

Example. (i) Facts. Individual H was hired by
Employer Y on May 3, 1995. Y maintains a group
health plan with a plan year beginning on February
1\. Under the terms of the plan, employees and their
dependents are allowed to enroll when the employee
is first hired (without a requirement to pass a physi-
cal examination), and on each February 1 thereafter
if the individual can pass a physical examination. H
chose not to enroll for coverage when hired in May
of 1995. On February 1, 1997, H tried to enroll for
coverage under the plan. However, H was denied
coverage for failure to pass a physical examination.
Shortly thereafter, Y's plan eliminated late enroll-
ment, and H was not given another opportunity to
enroll in the plan. There is no evidence to suggest
that Y's plan was acting in bad faith in denying cov-
erage under the plan beginning on the effective date
of section 9802 (February 1, 1998).

than July 1, 2001. (In addition, February 1, 1998 is
H's enrollment date under the plan and the period
between February 1, 1998 and July 1, 2001 is treat-
ed as a waiting period. Accordingly, any preexisting
condition exclusion period permitted under section
9801 will have expired before July 1, 2001.)

Robert E. Wenzel,
Deputy Commisioner
of Internal Revenue.

Approved August 8, 2000.

Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.

For the reasons set forth above, 29 CFR
Part 2590 is amended as follows:

# PART 2590 [AMENDED] - RULES AND REGULATIONS FOR HEALTH INSURANCE PORTABILITY AND RENEWABILITY FOR GROUP HEALTH PLANS

1\. The authority citation for Part 2590
is revised to read as follows:

Authority: Secs. 107, 209, 505, 701-
703, 711-713, and 731-734 of ERISA (29
U.S.C. 1027, 1059, 1135, 1171-1173,
1181-1183, and 1191-1194), as amended
by HIPAA (Public Law 104-191, 110
Stat. 1936), MHPA and NMHPA (Public
Law 104-204, 110 Stat. 2935), and
WHCRA (Public Law 105-277, 112 Stat.
2681-436), section 101(g)(4) of HIPAA,
and Secretary of Labor's Order No. 1-87,
52 FR 13139, April 21, 1987.

2\. Section § 2590.702 is revised to
read as follows:

## § 2590.702 Prohibiting discrimination against participants and beneficiaries based on a health factor.

(a) Health factors. (1) The term health
factor means, in relation to an individual,
any of the following health status-related
factors:

(i) Health status;

(ii) Medical condition (including both
physical and mental illnesses), as defined
in § 2590.701-2;

(iii) Claims experience;

(iv) Receipt of health care;

(v) Medical history;

(vi) Genetic information, as defined in
§ 2590.701-2;

(vii) Evidence of insurability; or

(viii) Disability.

(2) Evidence of insurability includes -

(i) Conditions arising out of acts of
domestic violence; and

(ii) Participation in activities such as
motorcycling, snowmobiling, all-terrain
vehicle riding, horseback riding, skiing,
and other similar activities.

(3) The decision whether health cover-
age is elected for an individual (including
the time chosen to enroll, such as under
special enrollment or late enrollment) is
not, itself, within the scope of any health
factor. (However, under § 2590.701-6, a
plan or issuer must treat special enrollees
the same as similarly situated individuals
who are enrolled when first eligible.)

(b) Prohibited discrimination in rules
for eligibility - (1) In general - (i) A
group health plan, and a health insurance
issuer offering health insurance coverage
in connection with a group health plan,
may not establish any rule for eligibility
(including continued eligibility) of any
individual to enroll for benefits under the
terms of the plan or group health insur-
ance coverage that discriminates based on
any health factor that relates to that indi-
vidual or a dependent of that individual.
This rule is subject to the provisions of
paragraph (b)(2) of this section (explain-
ing how this rule applies to benefits),
paragraph (b)(3) of this section (allowing
plans to impose certain preexisting condi-
tion exclusions), paragraph (d) of this sec-
tion (containing rules for establishing
groups of similarly situated individuals),
paragraph (e) of this section (relating to
nonconfinement, actively-at-work, and
other service requirements), paragraph (f)
of this section (relating to bona fide well-
ness programs), and paragraph (g) of this
section (permitting favorable treatment of
individuals with adverse health factors).

(ii) For purposes of this section, rules
for eligibility include, but are not limited
to, rules relating to -

(A) Enrollment;

(B) The effective date of coverage;

(D) Late and special enrollment;

(E) Eligibility for benefit packages
(including rules for individuals to change
their selection among benefit packages);

(F) Benefits (including rules relating to
covered benefits, benefit restrictions, and
cost-sharing mechanisms such as coinsur-
ance, copayments, and deductibles), as
described in paragraphs (b)(2) and (3) of
this section;

(G) Continued eligibility; and

(H) Terminating coverage (including
disenrollment) of any individual under the
plan.

(iii) The rules of this paragraph (b)(1)
are illustrated by the following examples:

Example 4. (i) Facts. A group health plan applies
for a group health policy offered by an issuer. As
part of the application, the issuer receives health
information about individuals to be covered under
the plan. Individual A is an employee of the employ-
er maintaining the plan. A and A's dependents have
a history of high health claims. Based on the infor-
mation about A and A's dependents, the issuer
excludes A and A's dependents from the group poli-
cy it offers to the employer.

guaranteed available basis to all small employers
and to accept every eligible individual in every small
employer group.) If the plan provides coverage
through this policy and does not provide equivalent
coverage for A and A's dependents through other
means, the plan will also violate this paragraph
(b)(1).

(2) Application to benefits - (i)
General rule - (A) Under this section, a
group health plan or group health insur-
ance issuer is not required to provide cov-
erage for any particular benefit to any
group of similarly situated individuals.

(B) However, benefits provided under
a plan or through group health insurance
coverage must be uniformly available to
all similarly situated individuals (as
described in paragraph (d) of this section).
Likewise, any restriction on a benefit or
benefits must apply uniformly to all simi-
larly situated individuals and must not be
directed at individual participants or ben-
eficiaries based on any health factor of the
participants or beneficiaries (determined
based on all the relevant facts and circum-
stances). Thus, for example, a plan or
issuer may limit or exclude benefits in
relation to a specific disease or condition,
limit or exclude benefits for certain types
of treatments or drugs, or limit or exclude
benefits based on a determination of
whether the benefits are experimental or
not medically necessary, but only if the
benefit limitation or exclusion applies
uniformly to all similarly situated individ-
uals and is not directed at individual par-
ticipants or beneficiaries based on any
health factor of the participants or benefi-
ciaries. In addition, a plan or issuer may
impose annual, lifetime, or other limits on
benefits and may require the satisfaction
of a deductible, copayment, coinsurance,
or other cost-sharing requirement in order
to obtain a benefit if the limit or cost-shar-
ing requirement applies uniformly to all
similarly situated individuals and is not
directed at individual participants or ben-
eficiaries based on any health factor of the
participants or beneficiaries. In the case
of a cost-sharing requirement, see also
paragraph (b)(2)(ii) of this section, which
permits variances in the application of a
cost-sharing mechanism made available
under a bona fide wellness program.
(Whether any plan provision or practice
with respect to benefits complies with this
paragraph (b)(2)(i) does not affect
whether the provision or practice is per-
mitted under any other provision of the

Act, the Americans with Disabilities Act,
or any other law, whether State or feder-
al.)

(C) For purposes of this paragraph
(b)(2)(i), a plan amendment applicable to
all individuals in one or more groups of
similarly situated individuals under the
plan and made effective no earlier than the
first day of the first plan year after the
amendment is adopted is not considered
to be directed at any individual partici-
pants or beneficiaries.

(D) The rules of this paragraph
(b)(2)(i) are illustrated by the following
examples:

(ii) Conclusion. Under the facts of this Example
2, the plan violates this paragraph (b)(2)(i) because
the plan modification is directed at B based on B's
claim.

(ii) Conclusion. In this Example 3, the issuer
violates this paragraph (b)(2)(i) because benefits for
C's condition are available to other individuals in the
group of similarly situated individuals that includes
C but are not available to C. Thus, the benefits are
not uniformly available to all similarly situated indi-
viduals. Even though the exclusionary rider is made
effective the first day of the next plan year, because
the rider does not apply to all similarly situated indi-
viduals, the issuer violates this paragraph (b)(2)(i).

Example 4. (i) Facts. A group health plan has a
$2,000 lifetime limit for the treatment of temporo-
mandibular joint syndrome (TMJ). The limit is

applied uniformly to all similarly situated individu-
als and is not directed at individual participants or
beneficiaries.

Example 5. (i) Facts. A group health plan applies
a $2 million lifetime limit on all benefits. However,
the $2 million lifetime limit is reduced to $10,000
for any participant or beneficiary covered under the
plan who has a congenital heart defect.

Example 6. (i) Facts. A group health plan limits
benefits for prescription drugs to those listed on a
drug formulary. The limit is applied uniformly to all
similarly situated individuals and is not directed at
individual participants or beneficiaries.

(ii) Cost-sharing mechanisms and
wellness programs. A group health plan
or group health insurance coverage with a
cost-sharing mechanism (such as a
deductible, copayment, or coinsurance)
that requires a higher payment from an
individual, based on a health factor of that
individual or a dependent of that individ-
ual, than for a similarly situated individual
under the plan (and thus does not apply
uniformly to all similarly situated individ-
uals) does not violate the requirements of
this paragraph (b)(2) if the payment dif-

ferential is based on whether an individual
has complied with the requirements of a
bona fide wellness program.

(iii) Specific rule relating to source-of-
injury exclusions - (A) If a group health
plan or group health insurance coverage
generally provides benefits for a type of
injury, the plan or issuer may not deny
benefits otherwise provided for treatment
of the injury if the injury results from an
act of domestic violence or a medical con-
dition (including both physical and mental
health conditions).

(B) The rules of this paragraph
(b)(2)(iii) are illustrated by the following
examples:

Example 2. (i) Facts. A group health plan pro-
vides benefits for head injuries generally. The plan
also has a general exclusion for any injury sustained
while participating in any of a number of recreation-
al activities, including bungee jumping. However,
this exclusion does not apply to any injury that
results from a medical condition (nor from domestic
violence). Participant E sustains a head injury while
bungee jumping. The injury did not result from a
medical condition (nor from domestic violence).
Accordingly, the plan denies benefits for E's head
injury.

(ii) Conclusion. In this Example 2, the plan pro-
vision that denies benefits based on the source of an
injury does not restrict benefits based on an act of
domestic violence or any medical condition.
Therefore, the provision is permissible under this
paragraph (b)(2)(iii) and does not violate this sec-
tion. (However, if the plan did not allow E to enroll
in the plan (or applied different rules for eligibility to
E) because E frequently participates in bungee jump-
ing, the plan would violate paragraph (b)(1) of this
section.)

(3) Relationship to § 2590.701-3. (i)
A preexisting condition exclusion is per-
mitted under this section if it -

(A) Complies with § 2590.701-3;

(B) Applies uniformly to all similarly
situated individuals (as described in para-
graph (d) of this section); and

factor of the participants or beneficiaries.
For purposes of this paragraph
(b)(3)(i)(C), a plan amendment relating to
a preexisting condition exclusion applica-
ble to all individuals in one or more
groups of similarly situated individuals
under the plan and made effective no ear-
lier than the first day of the first plan year
after the amendment is adopted is not con-
sidered to be directed at any individual
participants or beneficiaries.

(ii) The rules of this paragraph (b)(3)
are illustrated by the following examples:

Example 1. (i) Facts. A group health plan
imposes a preexisting condition exclusion on all
individuals enrolled in the plan. The exclusion
applies to conditions for which medical advice, diag-
nosis, care, or treatment was recommended or
received within the six-month period ending on an
individual's enrollment date. In addition, the exclu-
sion generally extends for 12 months after an indi-
vidual's enrollment date, but this 12-month period is
offset by the number of days of an individual's cred-
itable coverage in accordance with § 2590.701-3.
There is nothing to indicate that the exclusion is
directed at individual participants or beneficiaries.

(ii) Conclusion. In this Example 1, even though
the plan's preexisting condition exclusion discrimi-
nates against individuals based on one or more
health factors, the preexisting condition exclusion
does not violate this section because it applies uni-
formly to all similarly situated individuals, is not
directed at individual participants or beneficiaries,
and complies with § 2590.701-3 (that is, the require-
ments relating to the six-month look-back period,
the 12-month (or 18-month) maximum exclusion
period, and the creditable coverage offset).

(c) Prohibited discrimination in premi-
ums or contributions - (1) In general -
(i) A group health plan, and a health
insurance issuer offering health insurance
coverage in connection with a group

health plan, may not require an individual,
as a condition of enrollment or continued
enrollment under the plan or group health
insurance coverage, to pay a premium or
contribution that is greater than the premi-
um or contribution for a similarly situated
individual (described in paragraph (d) of
this section) enrolled in the plan or group
health insurance coverage based on any
health factor that relates to the individual
or a dependent of the individual.

(ii) List billing based on a health fac-
tor prohibited. However, a group health
insurance issuer, or a group health plan,
may not quote or charge an employer (or
an individual) a different premium for an
individual in a group of similarly situated
individuals based on a health factor. (But
see paragraph (g) of this section permit-
ting favorable treatment of individuals
with adverse health factors.)

(iii) Examples. The rules of this para-
graph (c)(2) are illustrated by the follow-
ing examples:

(ii) Conclusion. In this Example 1, the issuer
does not violate the provisions of this paragraph
(c)(2) because the issuer blends the rate so that the
employer is not quoted a higher rate for F than for a
similarly situated individual based on F's claims
experience.

Example 2. (i) Facts. Same facts as Example 1,
except that the issuer quotes the employer a higher
premium rate for F, because of F's claims experi-
ence, than for a similarly situated individual.

(ii) Conclusion. In this Example 2, the issuer vio-
lates this paragraph (c)(2). Moreover, even if the
plan purchased the policy based on the quote but did

not require a higher participant contribution for F
than for a similarly situated individual, the issuer
would still violate this paragraph (c)(2) (but in such
a case the plan would not violate this paragraph
(c)(2)).

(d) Similarly situated individuals. The
requirements of this section apply only
within a group of individuals who are
treated as similarly situated individuals.
A plan or issuer may treat participants as
a group of similarly situated individuals
separate from beneficiaries. In addition,
participants may be treated as two or more
distinct groups of similarly situated indi-
viduals and beneficiaries may be treated
as two or more distinct groups of similar-
ly situated individuals in accordance with
the rules of this paragraph (d). Moreover,
if individuals have a choice of two or
more benefit packages, individuals choos-
ing one benefit package may be treated as
one or more groups of similarly situated
individuals distinct from individuals
choosing another benefit package.

(1) Participants. Subject to paragraph
(d)(3) of this section, a plan or issuer may
treat participants as two or more distinct
groups of similarly situated individuals if
the distinction between or among the
groups of participants is based on a bona
fide employment-based classification
consistent with the employer's usual busi-
ness practice. Whether an employment-
based classification is bona fide is deter-
mined on the basis of all the relevant facts
and circumstances. Relevant facts and
circumstances include whether the
employer uses the classification for pur-
poses independent of qualification for
health coverage (for example, determin-
ing eligibility for other employee benefits
or determining other terms of employ-
ment). Subject to paragraph (d)(3) of this
section, examples of classifications that,
based on all the relevant facts and circum-
stances, may be bona fide include full-
time versus part-time status, different geo-
graphic location, membership in a
collective bargaining unit, date of hire,
length of service, current employee versus
former employee status, and different

occupations. However, a classification
based on any health factor is not a bona
fide employment-based classification,
unless the requirements of paragraph (g)
of this section are satisfied (permitting
favorable treatment of individuals with
adverse health factors).

(2) Beneficiaries - (i) Subject to para-
graph (d)(3) of this section, a plan or
issuer may treat beneficiaries as two or
more distinct groups of similarly situated
individuals if the distinction between or
among the groups of beneficiaries is
based on any of the following factors:

(A) A bona fide employment-based clas-
sification of the participant through whom
the beneficiary is receiving coverage;

(B) Relationship to the participant
(e.g., as a spouse or as a dependent child);

(D) With respect to children of a par-
ticipant, age or student status; or

(E) Any other factor if the factor is not
a health factor.

(ii) Paragraph (d)(2)(i) of this section
does not prevent more favorable treatment
of individuals with adverse health factors
in accordance with paragraph (g) of this
section.

(3) Discrimination directed at individ-
uals. Notwithstanding paragraphs (d)(1)
and (2) of this section, if the creation or
modification of an employment or cover-
age classification is directed at individual
participants or beneficiaries based on any
health factor of the participants or benefi-
ciaries, the classification is not permitted
under this paragraph (d), unless it is per-
mitted under paragraph (g) of this section
(permitting favorable treatment of indi-
viduals with adverse health factors).
Thus, if an employer modified an employ-
ment-based classification to single out,
based on a health factor, individual partic-
ipants and beneficiaries and deny them
health coverage, the new classification
would not be permitted under this section.

(4) Examples. The rules of this para-
graph (d) are illustrated by the following
examples:

Example 2. (i) Facts. Under a group health plan,
coverage is made available to employees, their
spouses, and their dependent children. However,
coverage is made available to a dependent child
only if the dependent child is under age 19 (or under
age 25 if the child is continuously enrolled full-time
in an institution of higher learning (full-time stu-
dents)). There is no evidence to suggest that these
classifications are directed at individual participants
or beneficiaries.

(ii) Conclusion. In this Example 2, treating
spouses and dependent children differently by
imposing an age limitation on dependent children,
but not on spouses, is permitted under this paragraph
(d). Specifically, the distinction between spouses
and dependent children is permitted under paragraph
(d)(2) of this section and is not prohibited under
paragraph (d)(3) of this section because it is not
directed at individual participants or beneficiaries. It
is also permissible to treat dependent children who
are under age 19 (or full-time students under age 25)
as a group of similarly situated individuals separate
from those who are age 25 or older (or age 19 or
older if they are not full-time students) because the
classification is permitted under paragraph (d)(2) of
this section and is not directed at individual partici-
pants or beneficiaries.

Example 3. (i) Facts. A university sponsors a
group health plan that provides one health benefit
package to faculty and another health benefit
package to other staff. Faculty and staff are treat-
ed differently with respect to other employee ben-
efits such as retirement benefits and leaves of
absence. There is no evidence to suggest that the
distinction is directed at individual participants or
beneficiaries.

(ii) Conclusion. In this Example 4, imposing
additional eligibility requirements on former
employees is permitted because a classification that
distinguishes between current and former employees
is a bona fide employment-based classification that
is permitted under this paragraph (d), provided that it
is not directed at individual participants or benefi-
ciaries. In addition, it is permissible to distinguish
between former employees who satisfy the service
requirement and those who do not, provided that the
distinction is not directed at individual participants
or beneficiaries. (However, former employees who

do not satisfy the eligibility criteria may, nonethe-
less, be eligible for continued coverage pursuant to a
COBRA continuation provision or similar State
law.)

(ii) Conclusion. Under the facts of this
Example 5, changing the coverage classification for
G based on the existing employment classification
for G is not permitted under this paragraph (d)
because the creation of the new coverage classifi-
cation for G is directed at G based on one or more
health factors.

(e) Nonconfinement and actively-at-
work provisions - (1) Nonconfinement
provisions - (i) General rule. Under
the rules of paragraphs (b) and (c) of this
section, a plan or issuer may not establish
a rule for eligibility (as described in para-
graph (b)(1)(ii) of this section) or set any
individual's premium or contribution rate
based on whether an individual is con-
fined to a hospital or other health care
institution. In addition, under the rules of
paragraphs (b) and (c) of this section, a
plan or issuer may not establish a rule for
eligibility or set any individual's premium
or contribution rate based on an individ-
ual's ability to engage in normal life activ-
ities, except to the extent permitted under
paragraphs (e)(2)(ii) and (3) of this sec-
tion (permitting plans and issuers, under
certain circumstances, to distinguish
among employees based on the perfor-
mance of services).

(ii) Examples. The rules of this para-
graph (e)(1) are illustrated by the follow-
ing examples:

offered by Issuer N. Under Issuer N's policy, items
and services provided in connection with the con-
finement of a dependent to a hospital or other health
care institution are not covered if the confinement is
covered under an extension of benefits clause from a
previous health insurance issuer.

(ii) Conclusion. In this Example 2, Issuer N vio-
lates this paragraph (e)(1) because the group health
insurance coverage restricts benefits (a rule for eligi-
bility under paragraph (b)(1)) based on whether a
dependent is confined to a hospital or other health
care institution that is covered under an extension of
benefits clause from a previous issuer. This section
does not affect any obligation Issuer M may have
under applicable State law to provide any extension
of benefits and does not affect any State law govern-
ing coordination of benefits.

(2) Actively-at-work and continuous ser-
vice provisions - (i) General rule - (A)
Under the rules of paragraphs (b) and (c) of
this section and subject to the exception for
the first day of work described in paragraph
(e)(2)(ii) of this section, a plan or issuer
may not establish a rule for eligibility (as
described in paragraph (b)(1)(ii) of this sec-
tion) or set any individual's premium or
contribution rate based on whether an indi-
vidual is actively at work (including
whether an individual is continuously
employed), unless absence from work due
to any health factor (such as being absent
from work on sick leave) is treated, for pur-
poses of the plan or health insurance cover-
age, as being actively at work.

(B) The rules of this paragraph (e)(2)(i)
are illustrated by the following examples:

Example 2. (i) Facts. Under a group health plan,
coverage for an employee becomes effective after 90
days of continuous service; that is, if an employee is
absent from work (for any reason) before completing
90 days of service, the beginning of the 90-day period
is measured from the day the employee returns to work
(without any credit for service before the absence).

(ii) Exception for the first day of work
-(A) Notwithstanding the general rule in
paragraph (e)(2)(i) of this section, a plan or
issuer may establish a rule for eligibility
that requires an individual to begin work
for the employer sponsoring the plan (or, in
the case of a multiemployer plan, to begin
a job in covered employment) before cov-
erage becomes effective, provided that
such a rule for eligibility applies regardless
of the reason for the absence.

(B) The rules of this paragraph (e)(2)(ii)
are illustrated by the following examples:

Example 2. (i) Facts. Under a group health plan,
coverage for new employees becomes effective on
the first day of the month following the employee's
first day of work, regardless of whether the employ-
ee is actively at work on the first day of the month.
Individual J is scheduled to begin work on March
24. However, Jis unable to begin work on March 24
because of illness. J begins working on April 7 and
J's coverage is effective May 1.

(ii) Conclusion. In this Example 2, the plan pro-
vision does not violate this section. However, as in
Example 1, if coverage for individuals absent from
work for reasons unrelated to a health factor became
effective despite their absence, then the plan would
violate this section.

(3) Relationship to plan provisions
defining similarly situated individuals -
(i) Notwithstanding the rules of para-
graphs (e)(1) and (2) of this section, a plan
or issuer may establish rules for eligibili-
ty or set any individual's premium or con-
tribution rate in accordance with the rules
relating to similarly situated individuals in
paragraph (d) of this section.
Accordingly, a plan or issuer may distin-
guish in rules for eligibility under the plan
between full-time and part-time employ-
ees, between permanent and temporary or
seasonal employees, between current and
former employees, and between employ-
ees currently performing services and
employees no longer performing services
for the employer, subject to paragraph (d)
of this section. However, other federal or

State laws (including the COBRA contin-
uation provisions and the Family and
Medical Leave Act of 1993) may require
an employee or the employee's depen-
dents to be offered coverage and set limits
on the premium or contribution rate even
though the employee is not performing
services.

(ii) The rules of this paragraph (e)(3)
are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan,
employees are eligible for coverage if they perform
services for the employer for 30 or more hours per
week or if they are on paid leave (such as vacation,
sick, or bereavement leave). Employees on unpaid
leave are treated as a separate group of similarly sit-
uated individuals in accordance with the rules of
paragraph (d) of this section.

(ii) Conclusion. In this Example 1, the plan pro-
visions do not violate this section. However, if the
plan treated individuals performing services for the
employer for 30 or more hours per week, individuals
on vacation leave, and individuals on bereavement
leave as a group of similarly situated individuals sep-
arate from individuals on sick leave, the plan would
violate this paragraph (e) (and thus also would violate
paragraph (b) of this section) because groups of sim-
ilarly situated individuals cannot be established based
on a health factor (including the taking of sick leave)
under paragraph (d) of this section.

(ii) Conclusion. In this Example 2, the plan provi-
sion does not violate this section because, under the
rules for similarly situated individuals allowing full-
time employees to be treated differently than part-time
employees, employees who work at least 250 hours in
a three-month period can be treated differently than
employees who fail to work 250 hours in that period.
The result would be the same if the plan permitted
individuals to apply excess hours from previous peri-
ods to satisfy the requirement for the current quarter.

(ii) Conclusion. In this Example 3, the plan pro-
vision terminating B's coverage upon B's termina-

tion of employment does not violate this section.

(ii) Conclusion. In this Example 4, the plan pro-
vision terminating C's coverage upon the cessation
of C's performance of services does not violate this
section.

(f) Bona fide wellness programs.
[Reserved.]

(g) More favorable treatment of indi-
viduals with adverse health factors per-
mitted - (1) In rules for eligibility - (i)
Nothing in this section prevents a group
health plan or group health insurance
issuer from establishing more favorable
rules for eligibility (described in para-
graph (b)(1) of this section) for individu-
als with an adverse health factor, such as
disability, than for individuals without the
adverse health factor. Moreover, nothing
in this section prevents a plan or issuer
from charging a higher premium or con-
tribution with respect to individuals with
an adverse health factor if they would not
be eligible for the coverage were it not for
the adverse health factor. (However, other
laws, including State insurance laws, may
set or limit premium rates; these laws are
not affected by this section.)

(ii) The rules of this paragraph (g)(1)
are illustrated by the following examples:

(ii) Conclusion. In this Example 1, the plan
provision allowing coverage for disabled depen-
dent children beyond age 23 satisfies this para-
graph (g)(1) (and thus does not violate this sec-
tion).

month for employee-only coverage and $250 per
month for family coverage. (This extended period of
coverage is without regard to whatever rights the
employee (or members of the employee's family)
may have for COBRA continuation coverage.)

(ii) Conclusion. In this Example 3, the plan pro-
vision allowing extended COBRA continuation cov-
erage for disabled individuals satisfies this para-
graph (g)(1) (and thus does not violate this section).
In addition, the plan is permitted, under this para-
graph (g)(1), to charge the disabled individuals a
higher premium for the extended coverage if the
individuals would not be eligible for COBRA con-
tinuation coverage were it not for the disability.
(Similarly, if the plan provided an extended period of
coverage for disabled individuals pursuant to State
law or plan provision rather than pursuant to a
COBRA continuation coverage provision, the plan
could likewise charge the disabled individuals a
higher premium for the extended coverage.)

(2) In premiums or contributions - (i)
Nothing in this section prevents a group
health plan or group health insurance
issuer from charging individuals a premi-
um or contribution that is less than the
premium (or contribution) for similarly
situated individuals if the lower charge is
based on an adverse health factor, such as
disability.

(ii) The rules of this paragraph (g)(2)
are illustrated by the following example:

(ii) Conclusion. In this Example, the plan provi-
sion waiving premium payment for disabled
employees is permitted under this paragraph (g)(2)
(and thus does not violate this section).

(h) No effect on other laws.
Compliance with this section is not deter-

minative of compliance with any other
provision of the Act (including the
COBRA continuation provisions) or any
other State or federal law, such as the
Americans with Disabilities Act.
Therefore, although the rules of this sec-
tion would not prohibit a plan or issuer
from treating one group of similarly situ-
ated individuals differently from another
(such as providing different benefit pack-
ages to current and former employees),
other federal or State laws may require
that two separate groups of similarly situ-
ated individuals be treated the same for
certain purposes (such as making the
same benefit package available to
COBRA qualified beneficiaries as is made
available to active employees). In addi-
tion, although this section generally does
not impose new disclosure obligations on
plans and issuers, this section does not
affect any other laws, including those that
require accurate disclosures and prohibit
intentional misrepresentation.

(i) Applicability dates - (1)
Paragraphs applicable March 9, 2001.
Paragraphs (a)(1), (a)(2)(i), (b)(1)(i),
(b)(1)(iii) Example 1, (b)(2)(i)(A),
(b)(2)(ii), (c)(1)(i),(c)(2)(i), and (c)(3) of
this section and this paragraph (i)(1) apply
to group health plans and health insurance
issuers offering group health insurance
coverage March 9, 2001.

(2) Paragraphs applicable for plan
years beginning on or after July 1, 2001.
Except as provided in paragraph (i)(3) of
this section, the provisions of this section
not listed in paragraph (i)(1) of this sec-
tion apply to group health plans and
health insurance issuers offering group
health insurance coverage for plan years
beginning on or after July 1, 2001.
Except as provided in paragraph (i)(3) of
this section, with respect to efforts to
comply with section 702 of the Act before
the first plan year beginning on or after
July 1, 2001, the Secretary will not take
any enforcement action against a plan that
has sought to comply in good faith with
section 702 of the Act.

paragraph (i)(3). Paragraph (i)(3)(ii) of
this section applies with respect to any
individual who was denied coverage if
the denial was not based on a good faith
interpretation of section 702 of the Act or
the Secretary's published guidance.
Under that paragraph, such an individual
must be allowed to enroll retroactively to
the effective date of section 702 of the
Act, or, if later, the date the individual
meets eligibility criteria under the plan
that do not discriminate based on any
health factor. Paragraph (i)(3)(iii) of this
section applies with respect to any indi-
vidual who was denied coverage based on
a good faith interpretation of section 702
of the Act or the Secretary's published
guidance. Under that paragraph, such an
individual must be given an opportunity
to enroll effective July 1, 2001. In either
event, whether under paragraph (i)(3)(ii)
or (iii) of this section, the Secretary will
not take any enforcement action with
respect to denials of coverage addressed
in this paragraph (i)(3) if the plan has
complied with the transitional rules of this
paragraph (i)(3).

(i) Denial of coverage clarified. For
purposes of this paragraph (i)(3), an indi-
vidual is considered to have been denied
coverage if the individual -

(A) Failed to apply for coverage
because it was reasonable to believe that
an application for coverage would have
been futile due to a plan provision that
discriminated based on a health factor; or

(B) Was not offered an opportunity to
enroll in the plan and the failure to give
such an opportunity violates this section.

(ii) Individuals denied coverage with-
out a good faith interpretation of the law
\- (A) Opportunity to enroll required. If
a plan or issuer has denied coverage to
any individual based on a health factor
and that denial was not based on a good
faith interpretation of section 702 of the
Act or any guidance published by the
Secretary, the plan or issuer is required to
give the individual an opportunity to
enroll (including notice of an opportunity
to enroll) that continues for at least 30
days. This opportunity must be presented
not later than March 9, 2001.

2001-7 I.R.B.

plan described in section 101(g)(3) of the
Health Insurance Portability and
Accountability Act of 1996), the coverage
must be effective within that first plan
year.

(2) If this enrollment opportunity is
presented after such plan year, the indi-
vidual must be given the choice of having
the coverage effective on either of the fol-
lowing two dates -

(i) The date the plan receives a request
for enrollment in connection with the
enrollment opportunity; or

(ii) Retroactively to the first day of the
first plan year beginning on the effective
date for the plan described in sections
101(g)(1) and (3) of the Health Insurance
Portability and Accountability Act of 1996
(or, if the individual otherwise first became
eligible to enroll for coverage after that
date, on the date the individual was other-
wise eligible to enroll in the plan). If an
individual elects retroactive coverage, the
plan or issuer is required to provide the
benefits it would have provided if the indi-
vidual had been enrolled for coverage dur-
ing that period (irrespective of any other-
wise applicable plan provisions governing
timing for the submission of claims). The
plan or issuer may require the individual to
pay whatever additional amount the indi-
vidual would have been required to pay for
the coverage (but the plan or issuer cannot
charge interest on that amount).

(B) Relation to preexisting condition
rules. For purposes of Part 7 of Subtitle B
of Title I of the Act, the individual may
not be treated as a late enrollee or as a spe-
cial enrollee. Moreover, the individual's
enrollment date is the effective date for
the plan described in sections 101(g)(1)
and (3) of the Health Insurance Portability
and Accountability Act (or, if the individ-
ual otherwise first became eligible to
enroll for coverage after that date, on the
date the individual was otherwise eligible
to enroll in the plan), even if the individ-
ual chooses under paragraph (i)(3)(ii)(A)
of this section to have coverage effective
only prospectively. In addition, any peri-
od between the individual's enrollment
date and the effective date of coverage is
treated as a waiting period.

Example 1. (i) Facts. Employer X maintains a
group health plan with a plan year beginning
October 1 and ending September 30. Individual F

was hired by Employer X before the effective date of
section 702 of the Act. Before the effective date of
section 702 of the Act for this plan (October 1,
1997), the terms of the plan allowed employees and
their dependents to enroll when the employee was
first hired, and on each January 1 thereafter, but in
either case, only if the individual could pass a phys-
ical examination. F's application to enroll when first
hired was denied because F had diabetes and could
not pass a physical examination. Upon the effective
date of section 702 of the Act for this plan (October
1, 1997), the plan is amended to delete the require-
ment to pass a physical examination. In November
of 1997, the plan gives F an opportunity to enroll in
the plan (including notice of the opportunity to
enroll) without passing a physical examination, with
coverage effective January 1, 1998.

(ii) Conclusion. In this Example 1, the plan com-
plies with the requirements of this paragraph (i)(3)(ii).

(ii) Conclusion. In this Example 2, beginning on
the effective date of section 702 of the Act for the plan
(January 1, 1998), the plan provision is not permitted
under any good faith interpretation of section 702 of
the Act or any guidance published by the Secretary.
Therefore, the plan is required, not later than March 9,
2001, to give G an opportunity to enroll (including
notice of the opportunity to enroll), with coverage
effective, at G's option, either retroactively from
January 1, 1998 or prospectively from the date G's
request for enrollment is received by the plan. If G
elects coverage to be effective beginning January 1,
1998, the plan can require G to pay any required
employee premiums for the retroactive coverage.

(iii) Individuals denied coverage based
on a good faith interpretation of the law
\- (A) Opportunity to enroll required. If
a plan or issuer has denied coverage to
any individual before the first day of the
first plan year beginning on or after July
1, 2001 based in part on a health factor
and that denial was based on a good faith
interpretation of section 702 of the Act or
guidance published by the Secretary, the
plan or issuer is required to give the indi-
vidual an opportunity to enroll (including
notice of an opportunity to enroll) that
continues for at least 30 days, with cover-
age effective no later than July 1, 2001.
Individuals required to be offered an
opportunity to enroll include individuals
previously offered enrollment without
regard to a health factor but subsequently
denied enrollment due to a health factor.

(B) Relation to preexisting condition
rules. For purposes of Part 7 of Subtitle B

of Title I of the Act, the individual may
not be treated as a late enrollee or as a spe-
cial enrollee. Moreover, the individual's
enrollment date is the effective date for
the plan described in sections 101(g)(1)
and (3) of the Health Insurance Portability
and Accountability Act (or, if the individ-
ual otherwise first became eligible to
enroll for coverage after that date, on the
date the individual was otherwise eligible
to enroll in the plan). In addition, any
period between the individual's enroll-
ment date and the effective date of cover-
age is treated as a waiting period.

(ii) Conclusion. In this Example, because cover-
age previously had been made available with respect
to H without regard to any health factor of H and
because Y's plan was acting in accordance with a
good faith interpretation of section 702 (and guidance
published by the Secretary), the failure of Y's plan to
allow H to enroll effective February 1, 1998 was per-
missible on that date. However, under the transition-
al rules of this paragraph (i)(3)(iii), Y's plan must give
H an opportunity to enroll that continues for at least
30 days, with coverage effective no later than July 1,
2001. (In addition, February 1, 1998 is H's enroll-
ment date under the plan and the period between
February 1, 1998 and July 1, 2001 is treated as a wait-
ing period. Accordingly, any preexisting condition
exclusion period permitted under § 2590.701-3 will
have expired before July 1, 2001.)

3\. The heading, paragraph (a)(1), and
the first sentence of paragraph (a)(2) of
§ 2590.736 of Part 2590 are revised to
read as follows:

## § 2590.736 Applicability dates.

(a) General applicability dates - (1)
Non-collectively bargained plans. Part 7 of
Subtitle B of Title I of the Act and
§§ 2590.701-1 through 2590.701-7,
2590.703, 2590.731 through 2590.734, and
this section apply with respect to group

2001-7 I.R.B.

health plans, and health insurance coverage
offered in connection with group health
plans, for plan years beginning after June 30,
1997, except as otherwise provided in this
section.

(2) Collectively-bargained plans. Except
as otherwise provided in this section (other
than in paragraph (a)(1) of this section), in
the case of a group health plan maintained
pursuant to one or more collective bargain-
ing agreements between employee represen-
tatives and one or more employers ratified
before August 21, 1996, Part 7 of Subtitle B
of Title I of the Act and §§ 2590.701-1
through 2590.701-7, 2590.703, 2590.731
through 2590.734, and this section do not
apply to plan years beginning before the
later of July 1, 1997, or the date on which the
last of the collective bargaining agreements
relating to the plan terminates (determined
without regard to any extension thereof
agreed to after August 21, 1996). * * *

* * * * *

Signed in Washington, DC, this 28th day
of December, 2000.

Leslie B. Kramerich,

Assistant Secretary, Pension and Welfare
Benefits Administration
U.S. Department of Labor.

For the reasons set forth above, 45 CFR
Part 146 is amended as follows:

# PART 146 [AMENDED] - RULES AND REGULATIONS FOR HEALTH INSURANCE PORTABILITY AND RENEWABILITY FOR GROUP HEALTH PLANS

1\. The authority citation for Part 146 is
revised to read as follows:

Authority: Secs. 2701 through 2763,
2791 and 2792 of the Public Health Service
Act, 42 U.S.C. 300gg through 300gg-63,
300gg-91, 300gg-92 as amended by
HIPAA (Public Law104-191, 110 Stat.
1936), MHPA and NMHPA (Public Law
104-204, 110 Stat. 2935), and WHCRA
(Public Law 105-277, 112 Stat. 2681-436),
and section 102(c)(4) of HIPAA.

2\. Section § 146.121 is revised to read
as follows:

§ 146.121 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

(a) Health factors. (1) The term
health factor means, in relation to an indi-

vidual, any of the following health status-
related factors:

(i) Health status;

(ii) Medical condition (including both
physical and mental illnesses), as defined
in § 144.103;

(iii) Claims experience;

(iv) Receipt of health care;

(v) Medical history;

(vi) Genetic information, as defined in
45 CFR 144.103;

(vii) Evidence of insurability; or

(viii) Disability.

(2) Evidence of insurability includes -

(i) Conditions arising out of acts of
domestic violence; and

(ii) Participation in activities such as
motorcycling, snowmobiling, all-terrain
vehicle riding, horseback riding, skiing,
and other similar activities.

(3) The decision whether health cover-
age is elected for an individual (including
the time chosen to enroll, such as under
special enrollment or late enrollment) is
not, itself, within the scope of any health
factor. (However, under § 146.117, a plan
or issuer must treat special enrollees the
same as similarly situated individuals who
are enrolled when first eligible.)

(ii) For purposes of this section, rules
for eligibility include, but are not limited
to, rules relating to -

(A) Enrollment;

(B) The effective date of coverage;

(D) Late and special enrollment;

(E) Eligibility for benefit packages
(including rules for individuals to change
their selection among benefit packages);

(G) Continued eligibility; and

(H) Terminating coverage (including
disenrollment) of any individual under the
plan.

(iii) The rules of this paragraph (b)(1)
are illustrated by the following examples:

er maintaining the plan. A and A's dependents have
a history of high health claims. Based on the infor-
mation about A and A's dependents, the issuer
excludes A and A's dependents from the group poli-
cy it offers to the employer.

(ii) Conclusion. In this Example 4, the issuer's
exclusion of A and A's dependents from coverage is
a rule for eligibility that discriminates based on one or
more health factors, and thus violates this paragraph
(b)(1). (If the employer is a small employer under 45
CFR 144.103 (generally, an employer with 50 or
fewer employees), the issuer also may violate 45 CFR
146.150, which requires issuers to offer all the poli-
cies they sell in the small group market on a guaran-
teed available basis to all small employers and to
accept every eligible individual in every small
employer group.) If the plan provides coverage
through this policy and does not provide equivalent
coverage for A and A's dependents through other
means, the plan will also violate this paragraph (b)(1).

(B) However, benefits provided under a
plan or through group health insurance
coverage must be uniformly available to
all similarly situated individuals (as
described in paragraph (d) of this section).
Likewise, any restriction on a benefit or
benefits must apply uniformly to all simi-
larly situated individuals and must not be
directed at individual participants or bene-
ficiaries based on any health factor of the
participants or beneficiaries (determined
based on all the relevant facts and circum-
stances). Thus, for example, a plan or
issuer may limit or exclude benefits in
relation to a specific disease or condition,
limit or exclude benefits for certain types
of treatments or drugs, or limit or exclude
benefits based on a determination of
whether the benefits are experimental or
not medically necessary, but only if the
benefit limitation or exclusion applies uni-
formly to all similarly situated individuals
and is not directed at individual partici-
pants or beneficiaries based on any health
factor of the participants or beneficiaries.
In addition, a plan or issuer may impose
annual, lifetime, or other limits on benefits
and may require the satisfaction of a
deductible, copayment, coinsurance, or
other cost-sharing requirement in order to
obtain a benefit if the limit or cost-sharing
requirement applies uniformly to all simi-
larly situated individuals and is not direct-
ed at individual participants or beneficia-
ries based on any health factor of the

participants or beneficiaries. In the case of
a cost-sharing requirement, see also para-
graph (b)(2)(ii) of this section, which per-
mits variances in the application of a cost-
sharing mechanism made available under
a bona fide wellness program. (Whether
any plan provision or practice with respect
to benefits complies with this paragraph
(b)(2)(i) does not affect whether the provi-
sion or practice is permitted under any
other provision of ERISA, the Americans
with Disabilities Act, or any other law,
whether State or federal.)

(D) The rules of this paragraph
(b)(2)(i) are illustrated by the following
examples:

Example 2. (i) Facts. A group health plan has a $2
million lifetime limit on all benefits (and no other life-
time limits) for participants covered under the plan.
Participant B files a claim for the treatment of AIDS.
At the next corporate board meeting of the plan spon-
sor, the claim is discussed. Shortly thereafter, the plan
is modified to impose a $10,000 lifetime limit on ben-
efits for the treatment of AIDS, effective before the
beginning of the next plan year.

(ii) Conclusion. Under the facts of this Example 2,
the plan violates this paragraph (b)(2)(i) because the
plan modification is directed at B based on B's claim.

(ii) Conclusion. In this Example 3, the issuer
violates this paragraph (b)(2)(i) because benefits for

C's condition are available to other individuals in the
group of similarly situated individuals that includes
C but are not available to C. Thus, the benefits are
not uniformly available to all similarly situated indi-
viduals. Even though the exclusionary rider is made
effective the first day of the next plan year, because
the rider does not apply to all similarly situated indi-
viduals, the issuer violates this paragraph (b)(2)(i).

Example 5. (i) Facts. A group health plan applies
a $2 million lifetime limit on all benefits. However,
the $2 million lifetime limit is reduced to $10,000
for any participant or beneficiary covered under the
plan who has a congenital heart defect.

(ii) Cost-sharing mechanisms and
wellness programs. A group health plan
or group health insurance coverage with a

cost-sharing mechanism (such as a
deductible, copayment, or coinsurance)
that requires a higher payment from an
individual, based on a health factor of that
individual or a dependent of that individ-
ual, than for a similarly situated individual
under the plan (and thus does not apply
uniformly to all similarly situated individ-
uals) does not violate the requirements of
this paragraph (b)(2) if the payment dif-
ferential is based on whether an individual
has complied with the requirements of a
bona fide wellness program.

(B) The rules of this paragraph
(b)(2)(iii) are illustrated by the following
examples:

Example 2. (i) Facts. A group health plan pro-
vides benefits for head injuries generally. The plan
also has a general exclusion for any injury sustained
while participating in any of a number of recreation-
al activities, including bungee jumping. However,
this exclusion does not apply to any injury that
results from a medical condition (nor from domestic
violence). Participant E sustains a head injury while
bungee jumping. The injury did not result from a
medical condition (nor from domestic violence).
Accordingly, the plan denies benefits for E's head
injury.

ing, the plan would violate paragraph (b)(1) of this
section.)

(3) Relationship to § 146.111. (i) A
preexisting condition exclusion is permit-
ted under this section if it -

(A) Complies with § 146.111;

(B) Applies uniformly to all similarly
situated individuals (as described in para-
graph (d) of this section); and

(ii) The rules of this paragraph (b)(3)
are illustrated by the following examples:

Example 1. (i) Facts. A group health plan
imposes a preexisting condition exclusion on all
individuals enrolled in the plan. The exclusion
applies to conditions for which medical advice, diag-
nosis, care, or treatment was recommended or
received within the six-month period ending on an
individual's enrollment date. In addition, the exclu-
sion generally extends for 12 months after an indi-
vidual's enrollment date, but this 12-month period is
offset by the number of days of an individual's cred-
itable coverage in accordance with § 146.111. There
is nothing to indicate that the exclusion is directed at
individual participants or beneficiaries.

(ii) Conclusion. In this Example 1, even though
the plan's preexisting condition exclusion discrimi-
nates against individuals based on one or more
health factors, the preexisting condition exclusion
does not violate this section because it applies uni-
formly to all similarly situated individuals, is not
directed at individual participants or beneficiaries,
and complies with § 146.111 (that is, the require-
ments relating to the six-month look-back period,
the 12-month (or 18-month) maximum exclusion
period, and the creditable coverage offset).

medical claims during the first six months following
enrollment are not treated the same as similarly situ-
ated individuals with no claims during that period.
(Under paragraph (d) of this section, the groups can-
not be treated as two separate groups of similarly sit-
uated individuals because the distinction is based on
a health factor.)

(c) Prohibited discrimination in premi-
ums or contributions - (1) In general-
(i) A group health plan, and a health
insurance issuer offering health insurance
coverage in connection with a group
health plan, may not require an individual,
as a condition of enrollment or continued
enrollment under the plan or group health
insurance coverage, to pay a premium or
contribution that is greater than the premi-
um or contribution for a similarly situated
individual (described in paragraph (d) of
this section) enrolled in the plan or group
health insurance coverage based on any
health factor that relates to the individual
or a dependent of the individual.

(iii) Examples. The rules of this para-
graph (c)(2) are illustrated by the follow-
ing examples:

(ii) Conclusion. In this Example 1, the issuer
does not violate the provisions of this paragraph

(c)(2) because the issuer blends the rate so that the
employer is not quoted a higher rate for F than for a
similarly situated individual based on F's claims
experience.

Example 2. (i) Facts. Same facts as Example 1,
except that the issuer quotes the employer a higher
premium rate for F, because of F's claims experi-
ence, than for a similarly situated individual.

(ii) Conclusion. In this Example 2, the issuer vio-
lates this paragraph (c)(2). Moreover, even if the
plan purchased the policy based on the quote but did
not require a higher participant contribution for F
than for a similarly situated individual, the issuer
would still violate this paragraph (c)(2) (but in such
a case the plan would not violate this paragraph
(c)(2)).

(d) Similarly situated individuals.
The requirements of this section apply
only within a group of individuals who
are treated as similarly situated individu-
als. A plan or issuer may treat partici-
pants as a group of similarly situated
individuals separate from beneficiaries.
In addition, participants may be treated
as two or more distinct groups of simi-
larly situated individuals and beneficia-
ries may be treated as two or more dis-
tinct groups of similarly situated
individuals in accordance with the rules
of this paragraph (d). Moreover, if indi-
viduals have a choice of two or more
benefit packages, individuals choosing
one benefit package may be treated as
one or more groups of similarly situated
individuals distinct from individuals
choosing another benefit package.

ment). Subject to paragraph (d)(3) of this
section, examples of classifications that,
based on all the relevant facts and circum-
stances, may be bona fide include full-
time versus part-time status, different geo-
graphic location, membership in a
collective bargaining unit, date of hire,
length of service, current employee versus
former employee status, and different
occupations. However, a classification
based on any health factor is not a bona
fide employment-based classification,
unless the requirements of paragraph (g)
of this section are satisfied (permitting
favorable treatment of individuals with
adverse health factors).

(2) Beneficiaries - (i) Subject to
paragraph (d)(3) of this section, a plan
or issuer may treat beneficiaries as two
or more distinct groups of similarly situ-
ated individuals if the distinction
between or among the groups of benefi-
ciaries is based on any of the following
factors:

(A) A bona fide employment-based
classification of the participant through
whom the beneficiary is receiving cover-
age;

(B) Relationship to the participant
(e.g., as a spouse or as a dependent child);

(D) With respect to children of a par-
ticipant, age or student status; or

(E) Any other factor if the factor is not
a health factor.

(ii) Paragraph (d)(2)(i) of this section
does not prevent more favorable treatment
of individuals with adverse health factors
in accordance with paragraph (g) of this
section.

(4) Examples. The rules of this para-
graph (d) are illustrated by the following
examples:

(ii) Conclusion. In this Example 2, treating
spouses and dependent children differently by
imposing an age limitation on dependent children,
but not on spouses, is permitted under this paragraph
(d). Specifically, the distinction between spouses
and dependent children is permitted under paragraph
(d)(2) of this section and is not prohibited under
paragraph (d)(3) of this section because it is not
directed at individual participants or beneficiaries. It
is also permissible to treat dependent children who
are under age 19 (or full-time students under age 25)
as a group of similarly situated individuals separate
from those who are age 25 or older (or age 19 or
older if they are not full-time students) because the
classification is permitted under paragraph (d)(2) of
this section and is not directed at individual partici-
pants or beneficiaries.

(ii) Examples. The rules of this para-
graph (e)(1) are illustrated by the follow-
ing examples:

does not become effective until the confinement
ends.

(2) Actively-at-work and continuous
service provisions - (i) General rule -
(A) Under the rules of paragraphs (b) and
(c) of this section and subject to the
exception for the first day of work
described in paragraph (e)(2)(ii) of this
section, a plan or issuer may not establish
a rule for eligibility (as described in para-
graph (b)(1)(ii) of this section) or set any
individual's premium or contribution rate
based on whether an individual is actively
at work (including whether an individual
is continuously employed), unless
absence from work due to any health fac-
tor (such as being absent from work on
sick leave) is treated, for purposes of the
plan or health insurance coverage, as
being actively at work.

(B) The rules of this paragraph (e)(2)(i)
are illustrated by the following examples:

Example 2. (i) Facts. Under a group health plan,
coverage for an employee becomes effective after 90
days of continuous service; that is, if an employee is

absent from work (for any reason) before completing
90 days of service, the beginning of the 90-day peri-
od is measured from the day the employee returns to
work (without any credit for service before the
absence).

(ii) Exception for the first day of
work - (A) Notwithstanding the general
rule in paragraph (e)(2)(i) of this section,
a plan or issuer may establish a rule for
eligibility that requires an individual to
begin work for the employer sponsoring
the plan (or, in the case of a multiemploy-
er plan, to begin a job in covered employ-
ment) before coverage becomes effective,
provided that such a rule for eligibility
applies regardless of the reason for the
absence.

(B) The rules of this paragraph
(e)(2)(ii) are illustrated by the following
examples:

(3) Relationship to plan provisions
defining similarly situated individuals -
(i) Notwithstanding the rules of para-
graphs (e)(1) and (2) of this section, a plan

or issuer may establish rules for eligibili-
ty or set any individual's premium or con-
tribution rate in accordance with the rules
relating to similarly situated individuals in
paragraph (d) of this section.
Accordingly, a plan or issuer may distin-
guish in rules for eligibility under the plan
between full-time and part-time employ-
ees, between permanent and temporary or
seasonal employees, between current and
former employees, and between employ-
ees currently performing services and
employees no longer performing services
for the employer, subject to paragraph (d)
of this section. However, other federal or
State laws (including the COBRA contin-
uation provisions and the Family and
Medical Leave Act of 1993) may require
an employee or the employee's depen-
dents to be offered coverage and set limits
on the premium or contribution rate even
though the employee is not performing
services.

(ii) The rules of this paragraph (e)(3)
are illustrated by the following examples:

Example 1. (i) Facts. Under a group health plan,
employees are eligible for coverage if they perform
services for the employer for 30 or more hours per
week or if they are on paid leave (such as vacation,
sick, or bereavement leave). Employees on unpaid
leave are treated as a separate group of similarly sit-
uated individuals in accordance with the rules of
paragraph (d) of this section.

(ii) Conclusion. In this Example 1, the plan pro-
visions do not violate this section. However, if the
plan treated individuals performing services for the
employer for 30 or more hours per week, individuals
on vacation leave, and individuals on bereavement
leave as a group of similarly situated individuals
separate from individuals on sick leave, the plan
would violate this paragraph (e) (and thus also
would violate paragraph (b) of this section) because
groups of similarly situated individuals cannot be
established based on a health factor (including the
taking of sick leave) under paragraph (d) of this sec-
tion.

in that period. The result would be the same if the
plan permitted individuals to apply excess hours
from previous periods to satisfy the requirement for
the current quarter.

(ii) Conclusion. In this Example 3, the plan pro-
vision terminating B's coverage upon B's termina-
tion of employment does not violate this section.

(ii) Conclusion. In this Example 4, the plan pro-
vision terminating C's coverage upon the cessation
of C's performance of services does not violate this
section.

(f) Bona fide wellness programs.
[Reserved.]

(ii) The rules of this paragraph (g)(1)
are illustrated by the following examples:

Example 1. (i) Facts. An employer sponsors a
group health plan that generally is available to employ-
ees, spouses of employees, and dependent children
until age 23. However, dependent children who are
disabled are eligible for coverage beyond age 23.

(ii) Conclusion. In this Example 1, the plan pro-
vision allowing coverage for disabled dependent
children beyond age 23 satisfies this paragraph
(g)(1) (and thus does not violate this section).

(2) In premiums or contributions - (i)
Nothing in this section prevents a group
health plan or group health insurance issuer
from charging individuals a premium or
contribution that is less than the premium
(or contribution) for similarly situated indi-
viduals if the lower charge is based on an

adverse health factor, such as disability.

(ii) The rules of this paragraph (g)(2)
are illustrated by the following example:

(ii) Conclusion. In this Example, the plan provi-
sion waiving premium payment for disabled
employees is permitted under this paragraph (g)(2)
(and thus does not violate this section).

(h) No effect on other laws.
Compliance with this section is not deter-
minative of compliance with any other
provision of the PHS Act (including the
COBRA continuation provisions) or any
other State or federal law, such as the
Americans with Disabilities Act.
Therefore, although the rules of this sec-
tion would not prohibit a plan or issuer
from treating one group of similarly situ-
ated individuals differently from another
(such as providing different benefit pack-
ages to current and former employees),
other federal or State laws may require
that two separate groups of similarly situ-
ated individuals be treated the same for
certain purposes (such as making the
same benefit package available to
COBRA qualified beneficiaries as is made
available to active employees). In addi-
tion, although this section generally does
not impose new disclosure obligations on
plans and issuers, this section does not
affect any other laws, including those that
require accurate disclosures and prohibit
intentional misrepresentation.

(i) Applicability dates - (1)
Paragraphs applicable March 9, 2001.
Paragraphs (a)(1), (a)(2)(i), (b)(1)(i),
(b)(1)(iii) Example 1, (b)(2)(i)(A),
(b)(2)(ii), (c)(1)(i), (c)(2)(i), and (c)(3) of
this section and this paragraph (i)(1) apply
to group health plans and health insurance
issuers offering group health insurance
coverage March 9, 2001.

(2) Paragraphs applicable for plan
years beginning on or after July 1, 2001.
Except as provided in paragraph (i)(3) or
(i)(4) of this section, the provisions of this
section not listed in paragraph (i)(1) of
this section apply to group health plans
and health insurance issuers offering
group health insurance coverage for plan
years beginning on or after July 1, 2001.
Except as provided in paragraph (i)(3) or

(i)(4) of this section, with respect to
efforts to comply with section 2702 of the
PHS Act before the first plan year begin-
ning on or after July 1, 2001, the
Secretary will not take any enforcement
action against an issuer or plan that has
sought to comply in good faith with sec-
tion 2702 of the PHS Act.

(3) Transitional rules for individuals
previously denied coverage based on a
health factor. This paragraph (i)(3) pro-
vides rules relating to individuals previ-
ously denied coverage under a group
health plan or group health insurance
coverage based on a health factor of the
individual. Paragraph (i)(3)(i) clarifies
what constitutes a denial of coverage
under this paragraph (i)(3). Paragraph
(i)(3)(ii) of this section applies with
respect to any individual who was denied
coverage if the denial was not based on a
good faith interpretation of section 2702
of the PHS Act or the Secretary's pub-
lished guidance. Under that paragraph,
such an individual must be allowed to
enroll retroactively to the effective date
of section 2702 of the PHS Act, or, if
later, the date the individual meets eligi-
bility criteria under the plan that do not
discriminate based on any health factor.
Paragraph (i)(3)(iii) of this section
applies with respect to any individual
who was denied coverage based on a
good faith interpretation of section 2702
of the PHS Act or the Secretary's pub-
lished guidance. Under that paragraph,
such an individual must be given an
opportunity to enroll effective July 1,
2001. In either event, whether under
paragraph (i)(3)(ii) or (iii) of this section,
the Secretary will not take any enforce-
ment action with respect to denials of
coverage addressed in this paragraph
(i)(3) if the issuer or plan has complied
with the transitional rules of this para-
graph (i)(3).

(i) Denial of coverage clarified. For
purposes of this paragraph (i)(3), an indi-
vidual is considered to have been denied
coverage if the individual -

(A) Failed to apply for coverage
because it was reasonable to believe that
an application for coverage would have
been futile due to a plan provision that
discriminated based on a health factor; or

(B) Was not offered an opportunity to
enroll in the plan and the failure to give

such an opportunity violates this section.

(ii) Individuals denied coverage with-
out a good faith interpretation of the law
\- (A) Opportunity to enroll required. If
a plan or issuer has denied coverage to
any individual based on a health factor
and that denial was not based on a good
faith interpretation of section 2702 of the
PHS Act or any guidance published by
the Secretary, the plan or issuer is
required to give the individual an oppor-
tunity to enroll (including notice of an
opportunity to enroll) that continues for
at least 30 days. This opportunity must
be presented not later than March 9,
2001\.

(1) If this enrollment opportunity was
presented before or within the first plan
year beginning on or after July 1, 1997 (or
in the case of a collectively bargained
plan, before or within the first plan year
beginning on the effective date for the
plan described in section 102(c) (3) of
the Health Insurance Portability and
Accountability Act of 1996), the coverage
must be effective within that first plan
year.

(2) If this enrollment opportunity is
presented after such plan year, the indi-
vidual must be given the choice of having
the coverage effective on either of the fol-
lowing two dates -

(i) The date the plan receives a request
for enrollment in connection with the
enrollment opportunity; or

(ii) Retroactively to the first day of the
first plan year beginning on the effective
date for the plan described in sections
102(c)(1) and (3) of the Health Insurance
Portability and Accountability Act of
1996 (or, if the individual otherwise first
became eligible to enroll for coverage
after that date, on the date the individual
was otherwise eligible to enroll in the
plan). If an individual elects retroactive
coverage, the plan or issuer is required to
provide the benefits it would have provid-
ed if the individual had been enrolled for
coverage during that period (irrespective
of any otherwise applicable plan provi-
sions governing timing for the submission
of claims). The plan or issuer may require
the individual to pay whatever additional
amount the individual would have been
required to pay for the coverage (but the
plan or issuer cannot charge interest on
that amount).

(B) Relation to preexisting condition
rules. For purposes of section 2701 of
the PHS Act, the individual may not be
treated as a late enrollee or as a special
enrollee. Moreover, the individual's
enrollment date is the effective date for
the plan described in sections 102(c)(1)
and (3) of the Health Insurance
Portability and Accountability Act (or, if
the individual otherwise first became eli-
gible to enroll for coverage after that
date, on the date the individual was oth-
erwise eligible to enroll in the plan),
even if the individual chooses under
paragraph (i)(3)(ii)(A) of this section to
have coverage effective only prospec-
tively. In addition, any period between
the individual's enrollment date and the
effective date of coverage is treated as a
waiting period.

Example 1. (i) Facts. Employer X maintains a
group health plan with a plan year beginning
October 1 and ending September 30. Individual F
was hired by Employer X before the effective date of
section 2702 of the PHS Act. Before the effective
date of section 2702 of the PHS Act for this plan
(October 1, 1997), the terms of the plan allowed
employees and their dependents to enroll when the
employee was first hired, and on each January 1
thereafter, but in either case, only if the individual
could pass a physical examination. F's application
to enroll when first hired was denied because F had
diabetes and could not pass a physical examination.
Upon the effective date of section 2702 of the PHS
Act for this plan (October 1, 1997), the plan is
amended to delete the requirement to pass a physical
examination. In November of 1997, the plan gives F
an opportunity to enroll in the plan (including notice
of the opportunity to enroll) without passing a phys-
ical examination, with coverage effective January 1,
1998.

(ii) Conclusion. In this Example 1, the plan com-
plies with the requirements of this paragraph
(i)(3)(ii).

(ii) Conclusion. In this Example 2, beginning on
the effective date of section 2702 of the PHS Act for
the plan (January 1, 1998), the plan provision is not
permitted under any good faith interpretation of sec-
tion 2702 of the PHS Act or any guidance published
by the Secretary. Therefore, the plan is required, not
later than March 9, 2001, to give G an opportunity to
enroll (including notice of the opportunity to enroll),
with coverage effective, at G's option, either retroac-

tively from January 1, 1998 or prospectively from
the date G's request for enrollment is received by the
plan. If G elects coverage to be effective beginning
January 1, 1998, the plan can require G to pay any
required employee premiums for the retroactive cov-
erage.

(iii) Individuals denied coverage based
on a good faith interpretation of the law
\- (A) Opportunity to enroll required. If
a plan or issuer has denied coverage to
any individual before the first day of the
first plan year beginning on or after July
1, 2001, based in part on a health factor
and that denial was based on a good faith
interpretation of section 2702 of the PHS
Act or guidance published by the
Secretary, the plan or issuer is required to
give the individual an opportunity to
enroll (including notice of an opportunity
to enroll) that continues for at least 30
days, with coverage effective no later than
July 1, 2001. Individuals required to be
offered an opportunity to enroll include
individuals previously offered enrollment
without regard to a health factor but sub-
sequently denied enrollment due to a
health factor.

(B) Relation to preexisting condition
rules. For purposes of section 2701 of the
PHS Act, the individual may not be treat-
ed as a late enrollee or as a special
enrollee. Moreover, the individual's
enrollment date is the effective date for
the plan described in sections 102(c)(1)
and (3) of the Health Insurance Portability
and Accountability Act (or, if the individ-
ual otherwise first became eligible to
enroll for coverage after that date, on the
date the individual was otherwise eligible
to enroll in the plan). In addition, any
period between the individual's enroll-
ment date and the effective date of cover-
age is treated as a waiting period.

Example. (i) Facts. Individual H was hired by
Employer Y on May 3, 1995. Y maintains a group
health plan with a plan year beginning on February
1\. Under the terms of the plan, employees and their
dependents are allowed to enroll when the employ-
ee is first hired (without a requirement to pass a
physical examination), and on each February 1
thereafter if the individual can pass a physical
examination. H chose not to enroll for coverage
when hired in May of 1995. On February 1, 1997,
H tried to enroll for coverage under the plan.
However, H was denied coverage for failure to pass
a physical examination. Shortly thereafter, Y's plan
eliminated late enrollment, and H was not given
another opportunity to enroll in the plan. There is
no evidence to suggest that Y's plan was acting in

bad faith in denying coverage under the plan begin-
ning on the effective date of section 2702 of the
PHS Act (February 1, 1998).

(ii) Conclusion. In this Example, because cover-
age previously had been made available with respect
to H without regard to any health factor of H and
because Y's plan was acting in accordance with a
good faith interpretation of section 2702 of the PHS
Act (and guidance published by the Secretary), the
failure of Y's plan to allow H to enroll effective
February 1, 1998 was permissible on that date.
However, under the transitional rules of this para-
graph (i)(3)(iii), Y's plan must give H an opportuni-
ty to enroll that continues for at least 30 days, with
coverage effective no later than July 1, 2001. (In
addition, February 1, 1998 is H's enrollment date
under the plan and the period between February 1,
1998 and July 1, 2001 is treated as a waiting period.
Accordingly, any preexisting condition exclusion
period permitted under § 146.111 will have expired
before July 1, 2001.)

(4) Special transitional rule for self-
funded non-Federal governmental plans
exempted under 45 CFR 146.180 - (i) If
coverage has been denied to any individ-
ual because the sponsor of a self-funded
non-Federal governmental plan has elect-
ed under § 146.180 to exempt the plan
from the requirements of this section, and
the plan sponsor subsequently chooses to
bring the plan into compliance with the
requirements of this section, the plan -

(A) Must notify the individual that the
plan will be coming into compliance with
the requirements of this section, specify
the effective date of compliance, and
inform the individual regarding any
enrollment restrictions that may apply
under the terms of the plan once the plan
is in compliance with this section (as a
matter of administrative convenience, the
notice may be disseminated to all employ-
ees);

(B) Must give the individual an oppor-
tunity to enroll that continues for at least
30 days;

(C) Must permit coverage to be effec-
tive as of the first day of plan coverage for
which an exemption election under
§ 146.180 (with regard to this section) is
no longer in effect (or July 1, 2001, if
later, and the plan was acting in accor-
dance with a good faith interpretation of
section 2702 of the PHS Act and guidance
published by HCFA); and

(D) May not treat the individual as a
late enrollee or a special enrollee.

(ii) For purposes of this paragraph
(i)(4), an individual is considered to have
been denied coverage if the individual
failed to apply for coverage because,
given an exemption election under

§ 146.180, it was reasonable to believe
that an application for coverage would
have been denied based on a health factor.

(iii) The rules of this paragraph (i)(4)
are illustrated by the following examples:

Example 1. (i) Facts. Individual D was hired
by a non-Federal governmental employer in June
1996. The employer maintains a self-funded group
health plan with a plan year beginning on October
1\. Under the terms of the plan, employees and
their dependents are allowed to enroll when the
employee is first hired without regard to any health
factor. If an individual declines to enroll when
first eligible, the individual may enroll effective
October 1 of any plan year if the individual can
pass a physical examination. The plan sponsor
elected under § 146.180 of this part to exempt the
plan from the requirements of this section for the
plan year beginning October 1, 1997, and renewed
the exemption election for the plan year beginning
October 1, 1998. That is, the plan sponsor elected
to retain the evidence of good health requirement
for late enrollees which, absent an exemption elec-
tion under § 146.180 of this part, would have been
in violation of this section as of October 1, 1997.
D chose not to enroll for coverage when first hired.
In February of 1998, D was treated for skin cancer
but did not apply for coverage under the plan for
the plan year beginning October 1, 1998, because
D assumed D could not meet the evidence of good
health requirement. With the plan year beginning
October 1, 1999, the plan sponsor chose not to
renew its exemption election and brought the plan
into compliance with this section. However, the
terms of the plan, effective October 1, 1999, were
amended to permit enrollment only during the ini-
tial 30-day period of employment. The plan no
longer permits late enrollment under any circum-
stances, including with respect to current employ-
ees not enrolled in the plan. Therefore, D was not
given another opportunity to enroll in the plan.
There is no evidence to suggest that the plan was
acting in bad faith in denying D coverage under the
plan beginning on the effective date of
§ 146.121 for the plan (October 1, 1999).

(ii) Conclusion. In this Example 1, because the
plan under § 146.180 was previously excluded from
the requirements of § 146.121 and thereafter was
acting in accordance with a good faith interpretation
of § 146.121 and guidance published by HCFA, the
failure of the plan to give D an opportunity to enroll
effective October 1, 1999 was permissible on that
date. However, under the transitional rules of this
paragraph (i)(4), the plan must give D an opportuni-

ty to enroll that continues for at least 30 days, with
coverage effective no later than July 1, 2001.
(Additionally, October 1, 1999 is D's enrollment
date under the plan and the period between October
1, 1999 and July 1, 2001 is treated as a waiting peri-
od. Furthermore, if the plan sponsor has not elected
to exempt the plan from limitations on preexisting
condition exclusion periods, any preexisting condi-
tion exclusion period must be administered in accor-
dance with § 146.111. Accordingly, any preexisting
condition exclusion period permitted under
§ 146.111 will have expired before July 1, 2001.)

Example 2. (i) Facts. Individual E was hired by
a non-Federal governmental employer in February
1995. The employer maintains a self-funded group
health plan with a plan year beginning on September
1\. Under the terms of the plan, employees and their
dependents are allowed to enroll when the employee
is first hired without regard to any health factor. If
an individual declines to enroll when first eligible,
the individual may enroll effective September 1 of
any plan year if the individual can pass a physical
examination. All enrollees are subject to a 12-month
preexisting condition exclusion period. The plan
sponsor elected under § 146.180 of this part to
exempt the plan from the requirements of this sec-
tion and § 146.111 (limitations on preexisting condi-
tion exclusion periods) for the plan year beginning
September 1, 1997, and renews the exemption elec-
tion for the plan years beginning September 1, 1998,
September 1, 1999, and September 1, 2000. E chose
not to enroll for coverage when first hired. In June
of 2001, E is diagnosed as having multiple sclerosis
(MS). With the plan year beginning September 1,
2001, the plan sponsor chooses to bring the plan into
compliance with this section, but renews its exemp-
tion election with regard to limitations on preexist-
ing condition exclusion periods. The plan affords E
an opportunity to enroll, without a physical exami-
nation, effective September 1, 2001. E is subject to
a 12-month preexisting condition exclusion period
with respect to any treatment E receives that is relat-
ed to E's MS, without regard to any prior creditable
coverage E may have. Beginning September 1,
2002, the plan will cover treatment of E's MS.

(ii) Conclusion. In this Example 2, the plan com-
plies with the requirements of this section. (The plan
is not required to comply with the requirements of §
146.111 because the plan continues to be exempted
from those requirements in accordance with the plan
sponsor's election under § 146.180.)

3\. The heading, paragraph (a)(1), and
the first sentence of paragraph (a)(2) of
§ 146.125 are revised to read as follows:

## § 146.125 Applicability dates.

(a) General applicability dates - (1)
Non-collectively bargained plans. Part A
of title XXVII of the PHS Act and
§§146.101 through 146.119, § 146.143,
§146.145, 45 CFR part 150, and this sec-
tion apply with respect to group health
plans, and health insurance coverage
offered in connection with group health
plans, for plan years beginning after June
30, 1997, except as otherwise provided in
this section.

(2) Collectively-bargained plans.
Except as otherwise provided in this sec-
tion (other than paragraph (a)(1) of this
section), in the case of a group health plan
maintained pursuant to one or more col-
lective bargaining agreements between
employee representatives and one or more
employers ratified before August 21,
1996, Part A of Title XXVII of the PHS
Act and §§ 146.101 through 146.119, §
146.143, § 146.145, 45 CFR part 150, and
this section do not apply to plan years
beginning before the later of July 1, 1997,
or the date on which the last of the collec-
tive bargaining agreements relating to the
plan terminates (determined without
regard to any extension thereof agreed to
after August 21, 1996). * * *
* * * * *

Dated June 22, 2000.

Nancy-Ann Min DeParle,
Administrator, Health Care
Financing Administration.

Approved August 29, 2000.

Donna E. Shalala,
Secretary.

(Filed by the Office of the Federal Register on Janu-
ary 5, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 8, 2001, 66 F.R.
1378)

# Part III. Administrative, Procedural, and Miscellaneous

## Weighted Average Interest Rate Update

### Notice 2001-15

Notice 88-73 provides guidelines for
determining the weighted average interest
rate and the resulting permissible range of

interest rates used to calculate current lia-
bility for the purpose of the full funding
limitation of § 412(c)(7) of the Internal
Revenue Code as amended by the Om-
nibus Budget Reconciliation Act of 1987
and as further amended by the Uruguay
Round Agreements Act, Pub. L. 103-465
(GATT).

The average yield on the 30-year Trea-
sury Constant Maturities for December
2000 is 5.49 percent.

The following rates were determined
for the plan years beginning in the month
shown below.

Month

Year

Weighted Average

90% to 105% Permissible Range

90% to 110% Permissible Range

January

2001

5.91

5.32 to 6.21

5.32 to 6.50

#### Drafting Information

The principal author of this notice is
Todd Newman of the Employee Plans,

Tax Exempt and Government Entities
Division. For further information re-
garding this notice, please call Mr. New-

man at (202) 283-9702 (not a toll-free
number).

26 CFR 601.202: Closing agreements.

## Rev. Proc. 2001-17

TABLE OF CONTENTS

PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM

SECTION 1. PURPOSE AND OVERVIEW

.01

Purpose

p. 592

.02 General principles underlying EPCRS

p. 592

.03 Overview

p. 592

SECTION 2. EFFECT OF THIS REVENUE PROCEDURE ON PROGRAMS

.01 Effect on programs

p. 593

.02 Future enhancements

p. 593

PART II. PROGRAM EFFECT AND ELIGIBILITY

SECTION 3. EFFECT OF EPCRS; RELIANCE

.01 Effect of EPCRS on Qualified Plans and SEPs

p. 594

.02

Effect of EPCRS on 403(b) Plans

p. 594

.03

Effect of EPCRS on SEPs

p. 594

.04

Compliance Statement

p. 594

.05

Other taxes and penalties

p. 594

.06 Reliance

p. 594

SECTION 4. PROGRAM ELIGIBILITY

.01

Programs for Qualified Plans and 403(b) Plans

p. 594

.02

Eligibility for other arrangements.

p. 594

.03

Effect of examination

p. 594

.04

Favorable Letter requirement

p. 594

.05

Established practices and procedures

p. 594

.06

Correction by plan amendment

p. 595

.07

Submission for a determination letter

p. 595

.08 Availability of correction of Employer Eligibility

Failure

p. 595

.09

Egregious failures

p. 595

.10 Diversion or misuse of plan assets

p. 595

# PART III. DEFINITIONS, CORRECTION PRINCIPLES, AND RULES OF GENERAL APPLICABILITY

SECTION 5.

DEFINITIONS

.01

Definitions for Qualified Plans

p. 595

.02

Definitions for 403(b) Plans

p. 596

.03

Under Examination

p. 597

.04

SEP

p. 597

SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01

Correction principles; rules of general

applicability

p. 597

.02

Correction principles

p. 597

.03

Correction of an Employer Eligibility Failure (only available under VCP general procedures,

VCT, and VCSEP)

p. 599

.04

Correction by plan amendment

p. 599

.05

Special rules relating to Excess Amounts

P. 599

.06

Correction under statute or regulations

p. 600

.07

Matters subject to excise taxes

p. 600

.08

Correction for SEPs

p. 600

.09

Confidentiality and disclosure

p. 600

.10

No effect on other law

p. 600

PART IV. SELF-CORRECTION (SCP)

SECTION 7. IN GENERAL

SECTION 8. SELF-CORRECTION OF INSIGNIFICANT OPERATIONAL FAILURES

.01

Requirements

p. 601

.02

Factors

p. 601

.03

Multiple failures

p. 601

.04

Examples

p. 601

SECTION 9. SELF-CORRECTION OF SIGNIFICANT OPERATIONAL FAILURES

.01

Requirements

p. 601

.02

Correction period

p. 601

.03

Correction by plan amendment

p. 602

.04

Substantial completion of correction

p. 602

.05

Examples

p. 602

PART V. VOLUNTARY CORRECTION WITH SERVICE APPROVAL (VCP)

SECTION 10. VCP GENERAL PROCEDURES

.01

VCP requirements

p. 602

.02

Identification of failures

p. 602

.03

Effect of VCP submission on examination

p. 602

.04

No concurrent examination activity

p. 602

.05

Submission of determination letter application

for plan amendments

p. 602

.06

Processing of submission

p. 602

.07

Compliance statement

p. 603

.08

Effect of compliance statement on examination.

p. 604

.09

Processing of determination letter applications

not submitted under VCP

p. 604

.10

Special rules relating to VCO

p. 604

.11

Special rules relating to VCS

p. 604

.12

Special rules relating to Anonymous (John Doe)

Submission Procedure

p. 604

.13

Special rules relating to VCT

p. 605

.14

Special rules relating to VCGroup

p. 605

.15

Special rules relating to VCSEP

p. 605

.16

Multiemployer and multiple employer plans

p. 605

SECTION 11.

APPLICATION PROCEDURES FOR VCP

.01

General Rules

p. 605

.02

Submission requirements

p. 606

.03

Submission requirements under special procedures

p. 606

.04

Required documents.

p. 606

.05

Date VCP fee due generally

p. 607

.06 Fee due earlier for VCO, VCS, Anonymous Submission,

VCGroup, and VCSEP

p. 607

.07

Signed submission

p. 607

.08

Power of attorney requirements

p. 607

.09

Penalty of perjury statement

p. 607

.10

Checklist

p. 607

.11

Designation

p. 607

.12

VCP mailing address

p. 607

.13 Maintenance of copies of submissions

p. 608

SECTION 12. VCP FEES

.01

VCP general procedure compliance fee

p. 608

.02

VCO fee

p. 609

.03

VCS fee

p. 609

.04

Fee for Anonymous Submission

p. 609

.05

VCT fee

p. 609

.06

VCGroup fees

p. 610

.07

VCSEP fees

p. 610

.08 Establishing amount of assets and number of plan participants

p. 610

PART VI. CORRECTION ON AUDIT (AUDIT CAP)

SECTION 13. DESCRIPTION OF AUDIT CAP

.01 Audit CAP requirements

p. 610

.02 Payment of sanction

p. 610

.03

Additional requirements

p. 610

.04

Failure to reach resolution

p. 610

.05

Effect of closing agreement

p. 610

.06

Other procedural rules.

p. 610

SECTION 14. AUDIT CAP SANCTION

.01

Determination of sanction

p. 610

.02 Factors considered

p. 611

.03 Transferred Assets

p. 611

PART VII. EFFECT ON OTHER DOCUMENTS; EFFECTIVE DATE; PAPERWORK REDUCTION ACT

SECTION 15. EFFECT ON OTHER DOCUMENTS

.01

Revenue procedures modified and superseded

p. 611

.02 Rev. Proc. 2001-8 modified

p. 611

SECTION 16. EFFECTIVE DATE

p. 611

SECTION 17. PAPERWORK REDUCTION ACT

p. 611

DRAFTING INFORMATION

APPENDIX A: OPERATIONAL FAILURES AND CORRECTIONS UNDER VCS

.01 General Rule.

p. 612

.02 Failure to properly provide the minimum top-heavy benefit under § 416 of the Code

to non-key employees.

p. 612

.03 Failure to satisfy the ADP test set forth in § 401(k)(3), the ACP test set forth in § 401(m)(2), or the multiple use test of § 401(m)(9).

p. 612

.04 Failure to distribute elective deferrals in excess of the § 402(g) limit (in

p. 612
contravention of § 401(a)(30)).

.05 Exclusion of an eligible employee from all contributions or accruals under the plan for
one or more plan years.
p. 612

p. 612

.06 Failure to timely pay the minimum distribution required under § 401 (a)(9)

.07 Failure to obtain participant and/or spousal consent for a distribution subject to the
participant and spousal consent rules under §§ 401(a)(11), 411(a)(11), and 417
p. 612

.08 Failure to satisfy the § 415 limits in a defined contribution plan
p. 613

# APPENDIX B: CORRECTION METHODS AND EXAMPLES; EARNINGS ADJUSTMENT METHODS AND EXAMPLES

SECTION 1. PURPOSE, ASSUMPTIONS FOR EXAMPLES AND SECTION REFERENCES

.01 Purpose

p. 613

.02 Assumptions for Examples

p. 613

.03 Section References

p. 613

SECTION 2. CORRECTION METHODS AND EXAMPLES

.01 ADP/ACP Failures
.

p. 613

.02 Exclusion of Eligible Employees
p. 615

.03 Vesting Failures.

p. 618

.04 § 415 Failures

p. 619

.05 Correction of Other Overpayment Failures
p. 621

.06 § 401(a)(17) Failures

p. 621

.07 Correction by Amendment Under VCP and SCP

p. 621

SECTION 3. EARNINGS ADJUSTMENT METHODS AND EXAMPLES

.01 Earnings Adjustment Methods

p. 622

.02 Examples

p. 624

APPENDIX C: VCP CHECKLIST
p. 627

## PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM

### SECTION 1. PURPOSE AND OVERVIEW

.01 Purpose. This revenue procedure
updates the comprehensive system of cor-
rection programs for sponsors of retire-
ment plans that are intended to satisfy the
requirements of § 401(a), § 403(a), or
§ 403(b) of the Internal Revenue Code
(the "Code"), but that have not met these
requirements for a period of time. This
system, the Employee Plans Compliance
Resolution System ("EPCRS"), permits
plan sponsors to correct these failures and
thereby continue to provide their employ-
ees with retirement benefits on a tax-
favored basis. The components of
EPCRS are the Self-Correction Program
("SCP"), the Voluntary Correction
Program ("VCP"), and the Audit Closing
Agreement Program ("Audit CAP").

.02 General principles underlying
EPCRS. EPCRS is based on the follow-
ing general principles:

· Sponsors and other administrators
of eligible plans should be encour-
aged to establish administrative
practices and procedures that ensure
that these plans are operated proper-
ly in accordance with the applicable
requirements of the Code.

· Sponsors and other administrators
of eligible plans should satisfy the
applicable plan document require-
ments of the Code.

· Plan sponsors and other adminis-
trators should make voluntary and
timely correction of any plan fail-
ures, whether involving discrimi-
nation in favor of highly compen-
sated employees, plan operations,
the terms of the plan document, or
adoption of a plan by an ineligible
employer. Timely and efficient
correction protects participating
employees by providing them
with their expected retirement
benefits, including favorable tax
treatment.

· Voluntary compliance is promot-
ed by providing for limited fees
for voluntary corrections

approved by the Service, thereby
reducing employers' uncertainty
regarding their potential tax lia-
bility and participants' potential
tax liability.

· Fees and sanctions should be grad-
uated in a series of steps so that
there is always an incentive to cor-
rect promptly.

· Sanctions for plan failures identi-
fied on audit should be reasonable
in light of the nature, extent, and
severity of the violation.

· Administration of EPCRS should
be consistent and uniform.

· Taxpayers should be able to rely
on the availability of EPCRS in
taking corrective actions to main-
tain the tax-favored status of their
plans.

.03 Overview. EPCRS includes the
following basic elements:

· Self-correction (SCP). A plan
sponsor that has established com-
pliance practices and procedures
may, at any time, correct insignif-
icant Operational Failures with-
out paying any fee or sanction. In

.
.

addition, in the case of a
Qualified Plan that is the subject
of a favorable determination letter
from the Service or in the case of
a 403(b) Plan, the plan sponsor
generally may correct even sig-
nificant Operational Failures
without payment of any fee or
sanction.

· Voluntary correction with Service
approval (VCP). A plan sponsor, at
any time before audit, may pay a
limited fee and receive the
Service's approval for correction.
Under VCP, there are special pro-
cedures for certain submissions
involving only Operational Fail
ures (Voluntary Correction of
Operational Failures ("VCO")),
and for certain submissions in
which limited Operational Failures
are being corrected using standard-
ized corrections (Voluntary Cor-
rection of Operational Failures
Standardized ("VCS")). VCP also
includes a special procedure that
applies to 403(b) Plans (Voluntary
Correction of Tax-sheltered
Annuity Failures ("VCT")), a spe-
cial procedure for anonymous sub-
missions ("Anonymous Sub-
mission Procedure"), a special
procedure for group submissions
(Voluntary Correction of Group
Failures ("VCGroup")), and a spe-
cial procedure that applies to SEPs
(Voluntary Correction of SEP
Failures ("VCSEPs")).

· Correction on audit (Audit CAP).
If a failure (other than a failure
corrected through SCP or VCP) is
identified on audit, the plan spon-
sor may correct the failure and pay
a sanction. The sanction imposed
will bear a reasonable relationship
to the nature, extent and severity of
the failure, taking into account the
extent to which correction
occurred before audit.

## SECTION 2. EFFECT OF THIS REVENUE PROCEDURE ON PROGRAMS

.01 Effect on programs. This revenue
procedure modifies and supersedes Rev.
Proc. 2000-16, 2000-6 I.R.B. 518,
which was the prior consolidated state-
ment of the correction programs under

EPCRS. Many of the modifications have
been made in response to public com-
ments, and further changes are expected
to be made in the future in response to
comments previously received. The
modifications to Rev. Proc. 2000-16 that
are reflected in this revenue procedure
include:

· combining the prior programs that
allow voluntary correction with
Service approval - previously
VCR, Walk-In CAP, and TVC -
into a single voluntary correction
program, called VCP. VCP
includes special procedures for
certain Operational Failures (VCO
and VCS, the successors to VCR
and SVP respectively) and for
403(b) Failures (VCT, the succes-
sor to TVC), and also includes
other new, special procedures
described below.

· renaming the previous APRSC
program the Self-Correction
Program (SCP).

· broadening the submission pro-
cedures under VCP to allow cer-
tain organizations, such as mas-
ter and prototype sponsors or
third-party administrators, to
receive a compliance statement
for correcting failures that affect
more than one Plan Sponsor
(VCGroup).

· revising the submission proce-
dures under VCP to allow Plan
Sponsors to submit a request on an
anonymous ("John Doe") basis.

· expanding EPCRS to add new pro-
cedures specially designed for
small employers that sponsor
SEPs, permitting small employers
to self-correct insignificant SEP
failures and making special
accommodation for SEP sponsors
under EPCRS to take into account
special circumstances affecting
them.

· extending the duration of the self-
correction period under SCP (the
former APRSC) for significant
operational compliance failures
where the Plan Sponsor accepts a
transfer of plan assets or effects a
plan merger in connection with a
corporate merger, acquisition, or
other transaction.

· facilitating correction under SCP,

VCP, and Audit CAP of previous
Qualification Failures by Plan
Sponsors that accept transfers of
plan assets or effects plan mergers
in connection with corporate trans-
actions.

· permitting correction through
retroactive amendment where
employees are permitted to begin
participation before they are eligi-
ble (see Example 22 in Appendix
B).

· permitting correction through
retroactive amendment under SCP
and VCO for failures related to
permitting hardship withdrawals,
providing benefits based on com-
pensation in excess of the section
401(a)(17) limit, and premature
participation by otherwise eligible
employees.

· permitting correction for employ-
ers that were not eligible to spon-
sor 401(k) plans at the time they
adopted the plans.

· clarifying that the ability to self-
correct insignificant failures con-
tinues to be available under SCP
during a plan examination,
whether the failure is identified by
the Plan Sponsor or by the Service.

· clarifying the reporting require-
ments applicable to excess distrib-
utions from qualified plans and
SEPs.

· clarifying how fees are calculated
with respect to multiemployer and
multiple employer plans.

· clarifying that a failure not dis-
closed by the Plan Sponsor, but
discovered by the Service during
the processing of a determination
letter submission is subject to the
sanction structure of Audit CAP.

· updating the definition of
Favorable Letter to take into
account GUST (as defined in sec-
tion 5.01(4)(d)).

.02 Future enhancements. (1) It is
expected that the EPCRS revenue proce-
dure will continue to be updated on a peri-
odic basis, including, as noted above, fur-
ther improvements to EPCRS based on
comments previously received. In addi-
tion, the Service and Treasury continue to
invite further comments on how to
improve EPCRS. Comments should be
sent to:

Internal Revenue Service
Attention: T:EP:RA:VC
1111 Constitution Avenue NW
Washington, D.C. 20224

(2) The Service and Treasury are
considering expanding the procedures
under EPCRS and are interested in receiv-
ing comments regarding, among other
things, appropriate correction procedures
for failures arising under Simple IRAs
(under § 408(p)). Submissions related to
Simple IRAs are currently being accepted
by the Service on a provisional basis out-
side of EPCRS.

(3) It is expected that procedural
changes may be made in EPCRS during
2001 in connection with the general reor-
ganization of the Service. For example,
the address to which comments, submis-
sions, and other correspondence is sent in
connection with EPCRS may be changed.
Such procedural changes will be
announced if and when they are made.

## PART II. PROGRAM EFFECT AND ELIGIBILITY

SECTION 3. EFFECT OF EPCRS;
RELIANCE

.01 Effect of EPCRS on Qualified
Plans. For a Qualified Plan, if the eligi-
bility requirements of section 4 are satis-
fied and the Plan Sponsor corrects a
Qualification Failure in accordance with
the applicable requirements of SCP in sec-
tion 7, VCP in sections 10 and 11, or
Audit CAP in section 13, the Service will
not treat the Qualified Plan as failing to
meet § 401(a). Thus, for example, if the
Plan Sponsor corrects the failures in

accordance with the requirements of this
revenue procedure, the plan will be treat-
ed as a qualified plan for purposes of
applying § 3121(a)(5) (FICA taxes) and
§ 3306(b)(5) (FUTA taxes).

.02 Effect of EPCRS on 403(b) Plans.
(1) Income taxes. For a 403(b) Plan, if the
applicable eligibility requirements of sec-
tion 4 are satisfied and the Plan Sponsor
corrects a failure in accordance with the
applicable requirements of SCP in section
7, VCP in sections 10 and 11, or Audit
CAP in section 13, the Service will not
pursue income inclusion for affected par-
ticipants, or liability for income tax with-
holding, on account of the failure.
However, the correction of a failure may

result in income tax consequences to par-
ticipants and beneficiaries (for example,
participants may be required to include in
gross income distributions of Excess
Amounts in the year of distribution).

(2) Excise and employment taxes.
Excise taxes, FICA taxes, and FUTA taxes
(and corresponding withholding obliga-
tions), if applicable, that result from a fail-
ure are not waived merely because the
failure has been corrected.

.03 Effect of EPCRS on SEPs. For a
SEP, if the eligibility requirements of
section 4 are satisfied and the Plan
Sponsor corrects a failure to satisfy the
requirements of § 408(k) in accordance
with the applicable requirements of SCP
in section 7 (but only if the correspond-
ing Qualification Failure is an insignifi-
cant Operational Failure), VCP in sec-
tions 10 and 11, or Audit CAP in section
13, the Service will not treat the SEP as
failing to meet § 408(k). Thus, for exam-
ple, if the Plan Sponsor corrects the fail-
ures in accordance with the require-
ments of this revenue procedure, the
SEP will be treated as satisfying
§ 408(k) for purposes of applying
§ 3121(a)(5) (FICA taxes) and
§ 3306(b)(5) (FUTA taxes).

.04 Compliance Statement. If a Plan
Sponsor or Eligible Organization receives
a compliance statement under VCP, the
compliance statement is binding upon the
Service and the Plan Sponsor or Eligible
Organization as provided in section 10.08.

.05 Other taxes and penalties. See sec-
tion 6.07 for rules relating to other taxes
and penalties.

.06 Reliance. Taxpayers may rely on
this revenue procedure, including the
relief described in sections 3.01, 3.02, and
3.03.

## SECTION 4. PROGRAM ELIGIBILITY

.01 Programs for Qualified Plans and
403(b) Plans. (1) SCP. Qualified Plans
and 403(b) Plans are eligible for SCP.
SCP is available only for Operational
Failures.

(2) VCP. Qualified Plans and 403(b)
Plans are eligible for VCP. VCP provides
general procedures for correction of all
Qualification Failures: Operational, Plan
Document, Demographic, and Employer
Eligibility.

(3) Audit CAP. Audit CAP is avail-
able for correction of all failures found on
examination that have not been corrected
in accordance with SCP or VCP.

.02 Eligibility for other arrangements.
(1) A SEP that is maintained under a Plan
Document is eligible for SCP with respect
to insignificant failures and is eligible for
VCP (under the special VCSEP proce-
dure). A SEP is also eligible for Audit
CAP. For purposes of EPCRS, a failure to
satisfy § 408(k) is treated like the corre-
sponding Qualification Failure. A failure
to satisfy § 408(k) includes a failure to
satisfy the 50%-eligible-employees elec-
tion requirement of § 408(k)(6)(A)(ii) and
a failure to satisfy the 25-employee limit
of § 408(k)(6)(B).

(2) The Service may extend EPCRS
to other arrangements.

.03 Effect of examination. If the plan
or Plan Sponsor is Under Examination,
VCP is not available. However, while the
plan or Plan Sponsor is Under
Examination, insignificant Operational
Failures can be corrected under SCP and,
if correction has been substantially com-
pleted before the plan or Plan Sponsor is
Under Examination, significant Opera-
tional Failures can be corrected under
SCP.

.04 Favorable Letter requirement.
VCO and the provisions of SCP relating
to significant Operational Failures (see
section 9) are available for a Qualified
Plan only if the plan is the subject of a
Favorable Letter.

.05 Established practices and proce-
dures. In order to be eligible for SCP, the
Plan Sponsor or administrator of a plan
must have established practices and pro-
cedures (formal or informal) reasonably
designed to promote and facilitate overall
compliance with applicable Code require-
ments. For example, the plan administra-
tor of a Qualified Plan that may be top-
heavy under § 416 may include in its plan
operating manual a specific annual step to
determine whether the plan is top-heavy
and, if so, to ensure that the minimum
contribution requirements of the top-
heavy rules are satisfied. A plan docu-
ment alone does not constitute evidence
of established procedures. In order for a
Plan Sponsor or administrator to use SCP,
these established procedures must have
been in place and routinely followed, and

an Operational Failure must have
occurred through an oversight or mistake
in applying them, because of an inadequa-
cy in the procedures, or because the fail-
ure relates to Transferred Assets and did
not occur after the end of the second plan
year that begins after the corporate merg-
er, acquisition, or other similar transac-
tion.

.06 Correction by plan amendment. (1)
Availability of correction by plan amend-
ment in VCP general procedures. A Plan
Sponsor may use VCP for a Qualified
Plan to correct an Operational Failure by
a plan amendment to conform the terms of
the plan to the plan's prior operations,
provided that the amendment complies
with the requirements of § 401(a), includ-
ing the requirements of §§ 401(a)(4),
410(b), and 411(d)(6).

(2) Certain correction by plan
amendment permitted in SCP and VCO. A
Plan Sponsor may use SCP or VCO for a
Qualified Plan to correct an Operational
Failure by a plan amendment to conform
the terms of the plan to the plan's prior
operations only to correct Operational
Failures listed in section 2.07 of Appendix
B. These failures must be corrected in
accordance with the correction methods
set forth in section 2.07 of Appendix B.
The amendment must comply with the
requirements of § 401(a), including the
requirements of §§ 401(a)(4), 410(b), and
411(d)(6). SCP and VCO are not other-
wise available for a Plan Sponsor to cor-
rect an Operational Failure by a plan
amendment. Thus, if loans were made to
participants, but the plan document did
not permit loans to be made to partici-
pants, the failure cannot be corrected
under SCP or VCO by retroactively
amending the plan to provide for the
loans. However, if a Plan Sponsor cor-
rects an Operational Failure in accordance
with SCP or VCO, it may amend the plan
to the extent necessary to reflect the cor-
rective action. For example, if the plan
failed to satisfy the average deferral per-
centage ("ADP") test required under
§ 401(k)(3) and the Plan Sponsor must
make qualified nonelective contributions
not already provided for under the plan,
the plan may be amended to provide for
qualified nonelective contributions. The
issuance of a compliance statement does
not constitute a determination as to the
effect of any plan amendment on the qual-
ification of the plan.

.07 Submission for a determination
letter. In a case in which correction of a
Qualification Failure includes correction
of a Plan Document Failure or correction
of an Operational Failure by plan amend-
ment, as permitted under section 4.06,
other than adoption of an amendment
designated by the Service as a model
amendment or standardized or prototype
plan, the amendment must be submitted
to the Service for approval using the
appropriate application form (i.e., the
Form 5300 series or, if permitted, Form
6406) to ensure that the amendment satis-
fies applicable qualification require-
ments.

.08 Availability of correction of
Employer Eligibility Failure. A Plan
Sponsor may use VCP general proce-
dures, VCT, and VCSEP to correct an
Employer Eligibility Failure. However,
under sections 4.01, 4.02, and 10, SCP,
VCO, and VCGroup are not available for
a Plan Sponsor to correct an Employer
Eligibility Failure.

.09 Egregious failures. SCP, VCO,
VCGroup, and VCSEP are not available
to correct failures that are egregious. For
example, if an employer has consistently
and improperly covered only highly
compensated employees or if a contribu-
tion to a defined contribution plan for a
highly compensated individual is several
times greater than the dollar limit set
forth in § 415, the failure would be con-
sidered egregious. VCP is available to
correct egregious failures; however,
these failures are subject to the fees
described in sections 12.01(4) and
12.05(6).

.10 Diversion or misuse of plan assets.
SCP, VCP, and Audit CAP are not avail-
able to correct failures relating to the
diversion or misuse of plan assets.

PART III. DEFINITIONS,
CORRECTION PRINCIPLES, AND
RULES OF GENERAL
APPLICABILITY

# SECTION 5. DEFINITIONS

The following definitions apply for
purposes of this revenue procedure:

.01 Definitions for Qualified Plans.
The definitions in this section 5.01 apply
to Qualified Plans.

(1) Qualified Plan. The term
"Qualified Plan" means a plan intended to
satisfy the requirements of § 401(a) or

§ 403(a).

(2) Qualification Failure. The term
"Qualification Failure" means any failure
that adversely affects the qualification of
a plan. There are four types of
Qualification Failures: (a) Plan
Document Failures, (b) Operational
Failures, (c) Demographic Failures, and
(d) Employer Eligibility Failures.

(a) Plan Document Failure. The
term "Plan Document Failure" means a
plan provision (or the absence of a plan
provision) that, on its face, violates the
requirements of § 401(a) or § 403(a).
Thus, for example, the failure of a plan to
be amended to reflect a new qualification
requirement within the plan's applicable
remedial amendment period under
§ 401(b) is a Plan Document Failure. For
purposes of this revenue procedure, a Plan
Document Failure includes any
Qualification Failure that is a violation of
the requirements of § 401(a) or § 403(a)
and that is not an Operational Failure,
Demographic Failure, or Employer
Eligibility Failure.

(b) Operational Failure. The term
"Operational Failure" means a
Qualification Failure (other than an
Employer Eligibility Failure) that arises
solely from the failure to follow plan pro-
visions. A failure to follow the terms of
the plan providing for the satisfaction of
the requirements of § 401(k) and § 401(m)
is considered to be an Operational Failure.
A plan does not have an Operational
Failure to the extent the plan is permitted
to be amended retroactively pursuant to
§ 401(b) or another statutory provision to
reflect the plan's operations. However, if
within an applicable remedial amendment
period under § 401(b), a plan has been
properly amended for statutory or regula-
tory changes and, on or after the later of
the date the amendment is effective or is
adopted, the amended provisions are not
followed, then the plan is considered to
have an Operational Failure.

(c) Demographic Failure. The
term "Demographic Failure" means a fail-
ure to satisfy the requirements of
§ 401(a)(4), § 401(a)(26), or § 410(b) that
is not an Operational Failure or an
Employer Eligibility Failure. The correc-
tion of a Demographic Failure generally
requires a corrective amendment to the
plan adding more benefits or increasing
existing benefits (cf., § 1.401(a)
(4)-11(g)).

2001-7 I.R.B.

(d) Employer Eligibility Failure.
The term "Employer Eligibility Failure"
means the adoption of a cash or deferred
arrangement (as defined in regulations
under § 401(k)) intended to satisfy the
requirements of § 401(k) for one or more
years between 1987 and 1996 (inclusive)
by an employer that was a tax-exempt
organization prohibited from adopting a
§ 401(k) plan during that period. An
Employer Eligibility Failure is not a Plan
Document, Operational, or Demographic
Failure.

(3) Excess Amount. The term
"Excess Amount" means (a) an
Overpayment, (b) an elective deferral or
employee after-tax contribution returned
to satisfy § 415, (c) an elective deferral in
excess of the limitation of § 402(g) that is
distributed, (d) an excess contribution or
excess aggregate contribution that is dis-
tributed to satisfy § 401(k) or § 401(m),
(e) an amount contributed on behalf of an
employee that is in excess of the employ-
ee's benefit provided under a SEP, (f) an
excess contribution that is distributed to
satisfy § 408(k)(6)(A)(iii), (g) for SEPs,
an elective deferral that is distributed to
satisfy the limitation of § 401(a)(17), or
(h) any similar amount that is required to
be distributed in order to maintain plan
qualification.

(4) Favorable Letter. The term
"Favorable Letter" means, in the case of a
Qualified Plan, a current favorable deter-
mination letter for an individually
designed plan (including a volume sub-
mitter plan), a current favorable opinion
letter for a Plan Sponsor that has adopted
a master or prototype plan, or a current
favorable notification letter for a Plan
Sponsor that has adopted a regional proto-
type plan. A plan has a current favorable
determination letter, opinion letter, or
notification letter if either (a), (b), (c), or
(d) below is satisfied:

(a) The plan has a favorable deter-
mination letter, opinion letter, or notifica-
tion letter that considers the Tax Reform
Act of 1986 ("TRA '86").

(b) The plan is a governmental
plan or non-electing church plan
described in Rev. Proc. 99-23, 1991-1
C.B. 920, and has a favorable determina-
tion, opinion, or notification letter that
considers the Tax Equity and Fiscal
Responsibility Act of 1982 ("TEFRA"),
the Deficit Reduction Act of 1984

("DEFRA"), and the Retirement Equity
Act of 1984 ("REA"), and the § 401(b)
remedial amendment period for TRA '86
has not yet expired.

(c) The plan is initially adopted or
effective after December 7, 1994, and the
Plan Sponsor timely submits an applica-
tion for a determination letter within the
plan's remedial amendment period under
§ 401(b).

(d) The plan is terminated prior to
the expiration of the applicable GUST reme-
dial amendment period under § 401(b) and
the plan was amended to reflect the provi-
sions of GUST. (GUST is an acronym for the
Uruguay Round Agreements Act (GATT),
the Uniformed Services Employment and
Reemployment Rights Act of 1994 (USER-
RA), the Small Business Job Protection Act
of 1996 (SBJPA), the Taxpayer Relief Act of
1997 (TRA '97), and the Internal Revenue
Service Restructuring and Reform Act of
1998 (RRA '98).)

(e) In the case of a SEP, the term
"Favorable Letter" means (i) a valid
Model Form 5305-SEP or 5305A-SEP
adopted by an employer in accordance
with the instructions on the applicable
Form, (ii) a current favorable opinion let-
ter for a Plan Sponsor that has adopted a
prototype SEP which has been amended
in accordance with procedures set forth in
Rev. Proc. 94-13, 1994-1 C.B. 566, to
take into account any applicable changes
in the law since the issuance of the opin-
ion letter, or (iii) in the case of an individ-
ually designed SEP, a private letter ruling
that has been issued for the SEP.

(5) Maximum Payment Amount.
The term "Maximum Payment Amount"
means a monetary amount that is approx-
imately equal to the tax the Service could
collect upon plan disqualification and is
the sum for the open taxable years of the:

(a) tax on the trust (Form 1041),

(b) additional income tax result-
ing from the loss of employer deductions
for plan contributions (and any interest or
penalties applicable to the Plan Sponsor's
return), and

(6) Overpayment. The term
"Overpayment" means a distribution to an
employee or beneficiary that exceeds the
employee's or beneficiary's benefit under
the terms of the plan because of a failure to

comply with plan terms that implement
§ 401(a)(17), § 401(m) (but only with
respect to the forfeiture of nonvested
matching contributions that are excess
aggregate contributions), § 411(a)(3)(G), or
§ 415. An Overpayment does not include a
distribution of any Excess Amount
described in section 5.01(3)(b) through (h).

(7) Plan Sponsor. The term "Plan
Sponsor" means the employer that estab-
lishes or maintains a qualified retirement
plan for its employees.

(8) Transferred Assets. The term
"Transferred Assets" means plan assets
that were received, in connection with a
corporate merger, acquisition or other
similar employer transaction, by the plan
in a transfer (including a merger or con-
solidation of plan assets) under § 414(l)
from a plan sponsored by an employer
that was not a member of the same con-
trolled group as the Plan Sponsor. If a
transfer of plan assets related to the same
employer transaction is accomplished
through several transfers, then the date of
the transfer is the date of the first transfer.

.02 Definitions for 403(b) Plans. The
definitions in this section 5.02 apply to
403(b) Plans.

(1) 403(b) Plan. The term "403(b)
Plan" means a plan or program intended
to satisfy the requirements of § 403(b).

(2) 403(b) Failure. A 403(b) Failure
is any Operational, Demographic, or
Employer Eligibility Failure as defined
below.

(a) Operational Failure. The term
"Operational Failure" means any of the
following:

(i) A failure to satisfy the
requirements of § 403(b)(12)(A)(ii)
(relating to the availability of salary
reduction contributions);

(ii) A failure to satisfy the
requirements of § 401(m) (as applied to
403(b) Plans pursuant to § 403(b)(12)(A)
(i));

(iii) A failure to satisfy the
requirements of § 401(a)(17) (as applied
to 403(b) Plans pursuant to § 403(b)(12)
(A)(i));

(iv) A failure to satisfy the dis-
tribution restrictions of § 403(b)(7) or
§ 403(b)(11);

(v) A failure to satisfy the inci-
dental death benefit rules of § 403(b)(10);
(vi) A failure to pay minimum
required distributions under § 403(b)(10);

(vii) A failure to give employees
the right to elect a direct rollover under
§ 403(b)(10), including the failure to give
meaningful notice of such right;

(viii) A failure of the annuity
contract or custodial agreement to provide
participants with a right to elect a direct
rollover under §§ 403(b)(10) and
401(a)(31);

(ix) A failure to satisfy the limit
on elective deferrals under § 403(b)
(1)(E);

(x) A failure of the annuity con-
tract or custodial agreement to provide the
limit on elective deferrals under
§§ 403(b)(1)(E) and 401(a)(30);

(xi) A failure involving contribu-
tions or allocations of Excess Amounts; or

(xii) Any other failure to satisfy
applicable requirements under § 403(b)
that (A) results in the loss of § 403(b) sta-
tus for the plan or the loss of § 403(b) sta-
tus for one or more custodial account(s) or
annuity contract(s) under the plan and (B)
is not a Demographic Failure, an
Employer Eligibility Failure, or a failure
related to the purchase of annuity con-
tracts, or contributions to custodial
accounts, on behalf of individuals who are
not employees of the employer.

(b) Demographic Failure. The
term "Demographic Failure" means a fail-
ure to satisfy the requirements of
§ 401(a)(4), § 401(a)(26), or § 410(b) (as
applied to 403(b) Plans pursuant to
§ 403(b)(12)(A)(i)).

(i) The adoption of a plan
intended to satisfy the requirements of
§ 403(b) by an employer that is not a tax-
exempt organization described in
§ 501(c)(3) or a public educational orga-
nization described in § 170(b)(1)(A)(ii);

(ii) A failure to satisfy the non-
transferability requirement of § 401(g);

(iii) A failure to initially estab-
lish or maintain a custodial account as
required by § 403(b)(7); or

(iv) A failure to purchase (ini-
tially or subsequently) either an annuity
contract from an insurance company
(unless grandfathered under Rev. Rul.
82-102, 1982-1 C.B. 62) or a custodial
account from a regulated investment com-
pany utilizing a bank or an approved non-
bank trustee/custodian.

(3) Excess Amount. The term
"Excess Amount" means any contribu-
tions or allocations that are in excess of
the limits under § 415 or § 403(b)(2)(the
exclusion allowance limit) for the year.

(4) Plan Sponsor. The term "Plan
Sponsor" means the employer that offers
a 403(b) Plan to its employees.

(5) Total Sanction Amount. The term
"Total Sanction Amount" means a mone-
tary amount that is approximately equal to
the income tax the Service could collect
as a result of the failure.

.03 Under Examination. (1) The term
"Under Examination" means: (a) a plan
that is under an Employee Plans examina-
tion (that is, an examination of a Form
5500 series or other Employee Plans
examination), or (b) a Plan Sponsor that is
under an Exempt Organizations examina-
tion (that is, an examination of a Form
990 series or other Exempt Organizations
examination).

(2) A plan that is under an Employee
Plans examination includes any plan for
which the Plan Sponsor, or a representa-
tive, has received verbal or written notifi-
cation from Employee Plans of an
impending Employee Plans examination,
or of an impending referral for an
Employee Plans examination, and also
includes any plan that has been under an
Employee Plans examination and is now
in Appeals or in litigation for issues raised
in an Employee Plans examination. A
plan is considered to be Under
Examination if it is aggregated for pur-
poses of satisfying the nondiscrimination
requirements of § 401(a)(4), the minimum
participation requirements of § 401(a)
(26), the minimum coverage requirements
of § 410(b), or the requirements of
§ 403(b)(12), with a plan(s) that is Under
Examination. In addition, a plan is con-
sidered to be Under Examination with
respect to a failure of a qualification
requirement (other than those described in
the preceding sentence) if the plan is
aggregated with another plan for purposes
of satisfying that qualification require-
ment (for example, § 402(g), § 415, or
§ 416) and that other plan is Under
Examination. For example, assume Plan
A has a § 415 failure, Plan A is aggregat-
ed with Plan B only for purposes of § 415,
and Plan B is Under Examination. In this
case, Plan A is considered to be Under
Examination with respect to the § 415

failure. However, if Plan A has a failure
relating to the spousal consent rules under
§ 417 or the vesting rules of § 411, Plan A
is not considered to be Under
Examination with respect to the § 417 or
§ 411 failure. For purposes of this rev-
enue procedure, the term aggregation
does not include consideration of benefits
provided by various plans for purposes of
the average benefits test set forth in
§ 410(b)(2).

(3) An Employee Plans examination
also includes a case in which a Plan
Sponsor has submitted a Form 5310 and
the Employee Plans agent notifies the
Plan Sponsor, or a representative, of pos-
sible Qualification Failures, whether or
not the Plan Sponsor is officially notified
of an "examination." This would include
a case where, for example, a Plan Sponsor
has applied for a determination letter on
plan termination, and an Employee Plans
agent notifies the Plan Sponsor that there
are partial termination concerns.

(4) A Plan Sponsor that is under an
Exempt Organizations examination
includes any Plan Sponsor that has
received (or whose representative has
received) verbal or written notification
from Exempt Organizations of an
impending Exempt Organizations exami-
nation or of an impending referral for an
Exempt Organizations examination and
also includes any Plan Sponsor that has
been under an Exempt Organizations
examination and is now in Appeals or in
litigation for issues raised in an Exempt
Organizations examination.

.04 SEP. The term "SEP" means a
plan intended to satisfy the requirements
of § 408(k). For purposes of this revenue
procedure, the term SEP also includes a
salary reduction SEP ("SARSEP")
described in § 408(k)(6), when applicable.

# SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01 Correction principles; rules of gen-
eral applicability. The general correction
principles in section 6.02 and rules of gen-
eral applicability in sections 6.03 through
6.10 apply for purposes of this revenue
procedure.

.02 Correction principles. Generally, a
failure is not corrected unless full correc-
tion is made with respect to all partici-
pants and beneficiaries, and for all taxable

years (whether or not the taxable year is
closed). Even if correction is made for a
closed taxable year, the tax liability asso-
ciated with that year will not be redeter-
mined because of the correction. In the
case of a Qualified Plan with an
Operational Failure, correction is deter-
mined taking into account the terms of the
plan at the time of the failure. Correction
should be accomplished taking into
account the following principles:

(1) Restoration of benefits. The cor-
rection method should restore the plan to
the position it would have been in had the
failure not occurred, including restoration
of current and former participants and
beneficiaries to the benefits and rights
they would have had if the failure had not
occurred.

(2) Reasonable and appropriate cor-
rection. The correction should be reason-
able and appropriate for the failure.
Depending on the nature of the failure,
there may be more than one reasonable
and appropriate correction for the failure.
For Qualified Plans, any correction
method permitted under Appendix A or
Appendix B is deemed to be a reasonable
and appropriate method of correcting the
related Qualification Failure. Any correc-
tion method permitted under Appendix A
applicable to a 403(b) Plan is deemed to
be a reasonable and appropriate method of
correcting the related 403(b) Failure.
Whether any other particular correction
method is reasonable and appropriate is
determined taking into account the applic-
able facts and circumstances and the fol-
lowing principles:

(a) The correction method should,
to the extent possible, resemble one
already provided for in the Code, regula-
tions thereunder, or other guidance of
general applicability. For example, for
Qualified Plans, the defined contribution
plan correction methods set forth in
§ 1.415-6(b)(6) would be the typical
means of correcting a failure under § 415.
Likewise, the correction method set forth
in § 1.402(g)-1(e)(2) would be the typical
means of correcting a failure under
§ 402(g).

(b) The correction method for
failures relating to nondiscrimination
should provide benefits for nonhighly
compensated employees. For example, for
Qualified Plans, the correction method set
forth in § 1.401(a)(4)-11(g) (rather than

methods making use of the special testing
provisions set forth in § 1.401(a)(4)-8 or
§ 1.401(a)(4)-9) would be the typical
means of correcting a failure to satisfy
nondiscrimination requirements. Simi-
larly, the correction of a failure to satisfy
the requirements of § 401(k)(3),
§ 401(m)(2), or § 401(m)(9) (relating to
nondiscrimination), solely by distributing
excess amounts to highly compensated
employees would not be the typical means
of correcting such a failure.

(c) The correction method should
keep plan assets in the plan, except to the
extent the Code, regulations, or other
guidance of general applicability provide
for correction by distribution to partici-
pants or beneficiaries or return of assets to
the employer or Plan Sponsor. For exam-
ple, if an excess allocation (not in excess
of the § 415 limits) made under a
Qualified Plan was made for a participant
under a plan (other than a cash or deferred
arrangement), the excess should be reallo-
cated to other participants or, depending
on the facts and circumstances, used to
reduce future employer contributions.

(d) The correction method should
not violate another applicable specific
requirement of § 401(a) or § 403(b) (for
example, § 401(a)(4), § 411(d)(6), or
§ 403(b)(12), as applicable), or § 408(k)
for SEPs. If an additional failure is creat-
ed as a result of the use of a correction
method in this revenue procedure, then
that failure also must be corrected in con-
junction with the use of that correction
method and in accordance with the
requirements of this revenue procedure.

(3) Consistency Requirement.
Generally, where more than one correc-
tion method is available to correct a type
of Operational Failure for a plan year (or
where there are alternative ways to apply
a correction method), the correction
method (or one of the alternative ways to
apply the correction method) should be
applied consistently in correcting all
Operational Failures of that type for that
plan year. Similarly, earnings adjustment
methods generally should be applied con-
sistently with respect to corrective contri-
butions or allocations for a particular type
of Operational Failure for a plan year.

(4) Principles regarding corrective
allocations and corrective distributions.
The following principles apply where an
appropriate correction method includes

the use of corrective allocations or correc-
tive distributions:

(a) Corrective allocations under a
defined contribution plan should be based
upon the terms of the plan and other
applicable information at the time of the
failure (including the compensation that
would have been used under the plan for
the period with respect to which a correc-
tive allocation is being made) and should
be adjusted for earnings (including losses)
and forfeitures that would have been allo-
cated to the participant's account if the
failure had not occurred. The corrective
allocation need not be adjusted for losses.
See section 3 of Appendix B for addition-
al information on calculation of earnings
for corrective allocations.

(b) A corrective allocation to a
participant's account because of a failure
to make a required allocation in a prior
limitation year will not be considered an
annual addition with respect to the partic-
ipant for the limitation year in which the
correction is made, but will be considered
an annual addition for the limitation year
to which the corrective allocation relates.
However, the normal rules of § 404,
regarding deductions, apply.

(c) Corrective allocations should
come only from employer contributions
(including forfeitures if the plan permits
their use to reduce employer contribu-
tions).

(d) In the case of a defined bene-
fit plan, a corrective distribution for an
individual should be increased to take into
account the delayed payment, consistent
with the plan's actuarial adjustments.

(5) Special exceptions to full correc-
tion. In general, a failure must be fully
corrected. Although the mere fact that
correction is inconvenient or burdensome
is not enough to relieve a Plan Sponsor of
the need to make full correction, full cor-
rection may not be required in certain sit-
uations because it is unreasonable or not
feasible. Even in these situations, the cor-
rection method adopted must be one that
does not have significant adverse effects
on participants and beneficiaries or the
plan, and that does not discriminate sig-
nificantly in favor of highly compensated
employees. The exceptions described
below specify those situations in which
full correction is not required.

(a) Reasonable estimates. If it is
not possible to make a precise calculation,

or the probable difference between the
approximate and the precise restoration of
a participant's benefits is insignificant and
the administrative cost of determining
precise restoration would significantly
exceed the probable difference, reason-
able estimates may be used in calculating
appropriate correction.

(b) Delivery of very small benefits.
If the total corrective distribution due a
participant or beneficiary is $20 or less,
the Plan Sponsor is not required to make
the corrective distribution if the reason-
able direct costs of processing and deliv-
ering the distribution to the participant or
beneficiary would exceed the amount of
the distribution.

(c) Locating lost participants.
Reasonable actions must be taken to find
all current and former participants and
beneficiaries to whom additional benefits
are due, but who have not been located
after a mailing to the last known address.
In general, such actions include use of the
Internal Revenue Service Letter
Forwarding Program (see Rev. Proc.
94-22, 1994-1 C.B. 608) or the Social
Security Administration Reporting
Service. A plan will not be considered to
have failed to correct a failure due to the
inability to locate an individual if either of
these programs is used; provided that, if
the individual is later located, the addi-
tional benefits must be provided to the
individual at that time.

(6) Reporting. Any distributions
from the plan should be properly reported.

.03 Correction of an Employer
Eligibility Failure (only available under
VCP general procedures, VCT, and
VCSEP). (1) The permitted correction of
an Employer Eligibility Failure is the ces-
sation of all contributions (including
salary reduction and after-tax contribu-
tions) beginning no later than the date the
application under VCP is filed. Pursuant
to VCP correction, the assets in such a
plan are to remain in the trust, annuity
contract, or custodial account and are to
be distributed no earlier than the occur-
rence of one of the applicable distribution
events, e.g., for 403(b) Plans, the events
described in § 403(b)(7) (to the extent the
assets are held in custodial accounts) or
§ 403(b)(11) (for those assets invested in
annuity contracts that would be subject to
§ 403(b)(11) restrictions if the employer

were eligible). A Plan that is corrected
through VCP will be treated as subject to
all of the requirements and provisions of
§ 401(a) for a Qualified Plan, § 403(b) for
a 403(b) Plan, and § 408(k) for a SEP
(including Code provisions relating to
rollovers).

(2) Cessation of contributions is not
required if continuation of contributions
would not be an Employer Eligibility
Failure (for example, a tax-exempt
employer may maintain a § 401(k) plan
after 1996).

(3) Because a plan with an Employer
Eligibility Failure will be treated as sub-
ject to all of the applicable Code qualifi-
cation requirements, the Plan Sponsor
must also correct all other failures in
accordance with this revenue procedure.

.04 Correction by plan amendment. In
any case in which correction of a
Qualified Plan failure includes correction
of a Plan Document Failure or correction
of an Operational Failure by plan amend-
ment as permitted under section 4.06,
other than adoption of a model amend-
ment or a standardized or prototype plan,
the amendment must be submitted to the
Service for approval under the appropriate
application form (i.e., Form 5300 series or
Form 6406) to ensure that the amendment
satisfies applicable qualification require-
ments.

.05 Special rules relating to Excess
Amounts. (1) Treatment of Excess
Amounts under Qualified Plans. A distri-
bution of an Excess Amount is not eligible
for the favorable tax treatment accorded
to distributions from Qualified Plans
(such as eligibility for rollover under
§ 402(c)). To the extent that a current or
prior distribution was a distribution of an
Excess Amount, distribution of that
Excess Amount is not an eligible rollover
distribution. Thus, for example, if such a
distribution was contributed to an individ-
ual retirement arrangement ("IRA"), the
contribution is not a valid rollover contri-
bution for purposes of determining the
amount of excess contributions (within
the meaning of § 4973) to the individual's
IRA. A distribution of an Excess Amount
is generally treated in the manner
described in section 3 of Rev. Proc.
92-93, 1992-2 C.B. 505, relating to the
corrective disbursement of elective defer-
rals. The distribution must be reported on

Forms 1099-R for the year of distribution
with respect to each participant or benefi-
ciary receiving such a distribution. Where
an Excess Amount has been distributed
the Plan Sponsor must notify the recipient
that (a) the Excess Amount was distrib-
uted and (b) the Excess Amount was not
eligible for favorable tax treatment
accorded to distributions from Qualified
Plans (and, specifically, was not eligible
for tax-free rollover).

(2) Treatment of Excess Amounts
under 403(b) Plans. (a) Distribution of
Excess Amounts. Excess Amounts for a
year, adjusted for earnings through the
date of distribution, must be distributed to
affected participants and beneficiaries and
are includible in their gross income in the
year of distribution. The distribution of
Excess Amounts is not an eligible rollover
distribution within the meaning of
§ 403(b)(8). A distribution of Excess
Amounts is generally treated in the man-
ner described in section 3 of Rev. Proc.
92-93, 1992-2 C.B. 505, relating to the
corrective disbursement of elective defer-
rals. The distribution must be reported on
Forms 1099-R for the year of distribution
with respect to each participant or benefi-
ciary receiving such a distribution. In
addition, the Plan Sponsor must inform
affected participants and beneficiaries that
the distribution of Excess Amounts is not
eligible for rollover. Excess Amounts dis-
tributed pursuant to this subparagraph
(2)(a) are not treated as amounts previ-
ously excludable under § 403(b)(2)(A)(ii)
for purposes of calculating the maximum
exclusion allowance for the taxable year
of the distribution and for subsequent tax-
able years.

(b) Retention of Excess Amounts.
Under VCT and Audit CAP, Excess
Amounts will be treated as corrected
(even though the Excess Amounts are
retained in the 403(b) Plan) if the follow-
ing requirements are satisfied. Excess
Amounts arising from a § 415 failure,
adjusted for earnings through the date of
correction, must reduce affected partici-
pants' applicable § 415 limit for the year
following the year of correction (or for the
year of correction if the Plan Sponsor so
chooses), and subsequent years, until the
excess is eliminated. Excess Amounts
(whether arising from a § 415 failure or a
§ 403(b)(2) failure), adjusted for earnings

through the date of correction, must also
reduce participants' exclusion allowances
by being treated as amounts previously
excludable under § 403(b)(2)(A)(ii)
beginning with the year following the
year of correction (or the year of correc-
tion if the Plan Sponsor so chooses). If
this correction method is used, it must
generally be used for all participants who
have Excess Amounts.

.06 Correction under statute or regula-
tions. Generally, none of the correction
programs are available to correct failures
that can be corrected under the Code and
related regulations. For example, as a
general rule, a Plan Document Failure that
is a disqualifying provision for which the
remedial amendment period under
§ 401(b) has not expired can be corrected
by operation of the Code through retroac-
tive remedial amendment.

.07 Matters subject to excise taxes. (1)
Except as provided in paragraph (3) of
this subsection, excise taxes and addition-
al taxes, to the extent applicable, are not
waived merely because the underlying
failure has been corrected or because the
taxes result from the correction. Thus, for
example, the excise tax on certain excess
contributions under § 4979 is not waived
under these correction programs.

(2) Except as provided in paragraph
(3) of this section, the correction pro-
grams are not available for events for
which the Code provides tax conse-
quences other than plan disqualification
(such as the imposition of an excise tax or
additional income tax). For example,
funding deficiencies (failures to make the
required contributions to a plan subject to
§ 412), prohibited transactions, and fail-
ures to file the Form 5500 cannot be cor-
rected under the correction programs.
However, if the event is also an
Operational Failure (for example, if the
terms of the plan document relating to
plan loans to participants were not fol-
lowed and loans made under the plan did
not satisfy § 72(p)(2)), the correction pro-
grams will be available to correct the
Operational Failure, even though the
excise or income taxes generally still will
apply.

(3) As part of VCP, if the failure
involves the failure to satisfy the mini-
mum required distribution requirements
of § 401(a)(9), in appropriate cases, the

Service will waive the excise tax under
§ 4974 applicable to plan participants.
The waiver will be included in the com-
pliance statement. The Plan Sponsor, as
part of the submission, must request the
waiver and in cases where the participant
subject to the excise tax is an owner-
employee, as defined in § 401(c)(3), or a
10 percent owner of a corporation, the
Plan Sponsor must also provide an expla-
nation supporting the request.

.08 Correction for SEPs. (1)
Correction for SEPs generally. Generally,
the correction for a SEP is expected to be
similar to the correction required for a
Qualified Plan with a similar
Qualification Failure.

(2) Special correction for SEPs.
Under VCSEP, in any case in which cor-
rection under section 6.08(1) is not feasi-
ble for a SEP or in any other case deter-
mined by the Service in its discretion
(including failures relating to §§ 402(g),
415, and 401(a)(17), failures relating to
deferral percentages, discontinuance of
contributions to a SARSEP, and retention
of overcontributions for cases in which
there has been no violation of a statutory
limitation), the Service may provide for a
different correction. See section 12.07 for
a special fee that may apply in such a
case.

(3) Correction of failure to satisfy
deferral percentage test. If the failure
involves a violation of the deferral per-
centage test under § 408(k)(6)(A)(iii)
applicable to a SARSEP, there are several
methods to correct the failure, similar to
the methods used in VCS and VCO. This
failure may be corrected in one of the fol-
lowing ways:

(a) The Plan Sponsor may make
contributions that are 100% vested to all
eligible nonhighly compensated employees
(to the extent permitted by § 415) necessary
to raise the deferral percentage needed to
pass the test. This amount may be calculat-
ed as either the same percentage of com-
pensation or the same flat dollar amount
(regardless of the terms of the SEP).

(b) The Plan Sponsor may effect
distribution of excess contributions,
adjusted for earnings through the date of
correction, to highly compensated em-
ployees to correct the failure. The Plan
Sponsor must also contribute to the SEP
an amount equal to the total amount dis-

tributed. This amount must be allocated to
(i) current employees who were nonhigh-
ly compensated employees in the year of
the failure, (ii) current nonhighly compen-
sated employees who were nonhighly
compensated employees in the year of the
failure, or (iii) employees (both current
and former) who were nonhighly compen-
sated employees in the year of the failure.

(4) Treatment of undercontributions
to a SEP. (a) Make-up contributions;
earnings. The Plan Sponsor should cor-
rect undercontributions to a SEP by con-
tributing make-up amounts that are fully
vested, adjusted for earnings credited
from the date of the failure to the date of
correction.

(b) Earnings adjustment methods.
(i) The earnings rate generally is based on
the investment results that would have
applied to the corrective contribution if
the failure had not occurred.

(ii) Insofar as SEP assets are
held in IRAs, there is no earnings rate
under the SEP as a whole. If the Plan
Sponsor is unable to determine what the
actual investment results would have
been, a reasonable interest rate may be
used.

.09 Confidentiality and disclosure.
Because each correction program relates
directly to the enforcement of the Code
qualification requirements, the informa-
tion received or generated by the Service
under the program is subject to the confi-
dentiality requirements of § 6103 and is
not a written determination within the
meaning of § 6110.

.10 No effect on other law. Correction
under these programs has no effect on the
rights of any party under any other law,
including Title I of the Employee
Retirement Income Security Act of 1974
("ERISA").

# PART IV. SELF-CORRECTION (SCP)

SECTION 7. IN GENERAL

The requirements of this section 7 are
satisfied with respect to an Operational
Failure if the Plan Sponsor of a Qualified
Plan, a 403(b) Plan, or a SEP satisfies the
requirements of section 8 (relating to
insignificant Operational Failures) or, in
the case of a Qualified Plan or a 403(b)
Plan, section 9 (relating to significant
Operational Failures).

# SECTION 8. SELF-CORRECTION OF INSIGNIFICANT OPERATIONAL FAILURES

.01 Requirements. The requirements
of this section 8 are satisfied with respect
to an Operational Failure if the
Operational Failure is corrected and,
given all the facts and circumstances, the
Operational Failure is insignificant. This
section 8 is available for correcting an
insignificant Operational Failure even if
the plan or Plan Sponsor is Under
Examination and even if the Operational
Failure is discovered by an agent on
examination.

.02 Factors. The factors to be consid-
ered in determining whether or not an
Operational Failure under a plan is
insignificant include, but are not limited
to: (1) whether other failures occurred
during the period being examined (for this
purpose, a failure is not considered to
have occurred more than once merely
because more than one participant is
affected by the failure); (2) the percentage
of plan assets and contributions involved
in the failure; (3) the number of years the
failure occurred; (4) the number of partic-
ipants affected relative to the total number
of participants in the plan; (5) the number
of participants affected as a result of the
failure relative to the number of partici-
pants who could have been affected by the
failure; (6) whether correction was made
within a reasonable time after discovery
of the failure; and (7) the reason for the
failure (for example, data errors such as
errors in the transcription of data, the
transposition of numbers, or minor arith-
metic errors). No single factor is determi-
native. Additionally, factors (2), (4), and
(5) should not be interpreted to exclude
small businesses.

.03 Multiple failures. In the case of a
plan with more than one Operational
Failure in a single year, or Operational
Failures that occur in more than one year,
the Operational Failures are eligible for
correction under this section 8 only if all
of the Operational Failures are insignifi-
cant in the aggregate. Operational
Failures that have been corrected under
SCP in section 9 and VCP in sections 10
and 11 are not taken into account for pur-
poses of determining if Operational
Failures are insignificant in the aggregate.

.04 Examples. The following exam-
ples illustrate the application of this sec-

tion 8. It is assumed, in each example,
that the eligibility requirements of section
4 relating to SCP have been satisfied and
that no Operational Failures occurred
other than the Operational Failures identi-
fied below.

Example 1: In 1984, Employer X established
Plan A, a profit-sharing plan that satisfies the
requirements of § 401(a) in form. In 1999, the ben-
efits of 50 of the 250 participants in Plan A were lim-
ited by § 415(c). However, when the Service exam-
ined Plan A in 2002, it discovered that, during the
1999 limitation year, the annual additions allocated
to the accounts of 3 of these employees exceeded the
maximum limitations under § 415(c). Employer X
contributed $3,500,000 to the plan for the plan year.
The amount of the excesses totaled $4,550. Under
these facts, because the number of participants
affected by the failure relative to the total number of
participants who could have been affected by the
failure, and the monetary amount of the failure rela-
tive to the total employer contribution to the plan for
the 1999 plan year, are insignificant, the § 415(c)
failure in Plan A that occurred in 1999 would be eli-
gible for correction under this section 8.

Example 2: The facts are the same as in Example
1, except that the failure to satisfy § 415 occurred
during each of the 1998, 1999, and 2000 limitation
years. In addition, the three participants affected by
the § 415 failure were not identical each year. The
fact that the § 415 failures occurred during more
than one limitation year did not cause the failures to
be significant; accordingly, the failures are still eligi-
ble for correction under this section 8.

Example 3: The facts are the same as in Example
1, except that the annual additions of 18 of the 50
employees whose benefits were limited by § 415(c)
nevertheless exceeded the maximum limitations
under § 415(c) during the 1999 limitation year, and
the amount of the excesses ranged from $1,000 to
$9,000, and totaled $150,000. Under these facts,
taking into account the number of participants
affected by the failure relative to the total number of
participants who could have been affected by the
failure for the 1999 limitation year (and the mone-
tary amount of the failure relative to the total
employer contribution), the failure is significant.
Accordingly, the § 415(c) failure in Plan A that
occurred in 1999 is ineligible for correction under
this section 8 as an insignificant failure.

Example 4: Employer J maintains Plan C, a
money purchase pension plan established in 1992.
The plan document satisfies the requirements of
§ 401(a) of the Code. The formula under the plan
provides for an employer contribution equal to 10%
of compensation, as defined in the plan. During its
examination of the plan for the 1999 plan year, the
Service discovered that the employee responsible for
entering data into the employer's computer made
minor arithmetic errors in transcribing the compen-
sation data with respect to 6 of the plan's 40 partici-
pants, resulting in excess allocations to those 6 par-
ticipants' accounts. Under these facts, the number of
participants affected by the failure relative to the
number of participants that could have been affected
is insignificant, and the failure is due to minor data
errors. Thus, the failure occurring in 1999 would be
insignificant and therefore eligible for correction
under this section 8.

Example 5: Public School maintains for its 200
employees a salary reduction 403(b) Plan (the
"Plan") that satisfies the requirements of § 403(b).
The business manager has primary responsibility for
administering the Plan, in addition to other adminis-
trative functions within Public School. During the
1998 plan year, a former employee should have
received an additional minimum required distribu-
tion of $278 under § 403(b)(10). Another participant
received an impermissible hardship withdrawal of
$2,500. Another participant made elective deferrals
of $11,000, $1,000 of which was in excess of the
§ 402(g) limit. Under these facts, even though mul-
tiple failures occurred in a single plan year, the fail-
ures will be eligible for correction under this section
8 because in the aggregate the failures are insignifi-
cant.

# SECTION 9. SELF-CORRECTION OF SIGNIFICANT OPERATIONAL FAILURES

.01 Requirements. The requirements
of this section 9 are satisfied with respect
to an Operational Failure (even if signifi-
cant) if the Operational Failure is correct-
ed and the correction is either completed
or substantially completed (in accordance
with section 9.04) by the last day of the
correction period described in section
9.02.

.02 Correction period. (1) End of cor-
rection period. The last day of the correc-
tion period for an Operational Failure is
the last day of the second plan year fol-
lowing the plan year for which the failure
occurred. However, in the case of a fail-
ure to satisfy the requirements of
§ 401(k)(3), 401(m)(2), or 401(m)(9), the
correction period does not end until the
last day of the second plan year following
the plan year that includes the last day of
the additional period for correction per-
mitted under § 401(k)(8) or 401(m)(6). If
a 403(b) Plan does not have a plan year,
the plan year is deemed to be the calendar
year for purposes of this subsection.

(2) Extension of correction period for
Transferred Assets. In the case of an
Operational Failure that relates only to
Transferred Assets, the correction period
does not end until the last day of the first plan
year that begins after the corporate merger,
acquisition, or other similar employer trans-
action between the Plan Sponsor and the
sponsor of the transferor plan.

(3) Effect of examination. The cor-
rection period for an Operational Failure
that occurs for any plan year ends, in any
event, on the first date the plan or Plan
Sponsor is Under Examination for that
plan year (determined without regard to

the second sentence of section 9.02). (But
see section 9.04 for special rules permit-
ting completion of correction after the end
of the correction period.)

.03 Correction by plan amendment. In
order to complete correction by plan
amendment (as permitted under section
4.06) during the correction period, the
appropriate application (i.e., the Form
5300 series or Form 6406) must be sub-
mitted before the end of the correction
period.

.04 Substantial completion of correc-
tion. Correction of an Operational Failure
is substantially completed by the last day
of the correction period only if the
requirements of either paragraph (1) or (2)
are satisfied.

(1) The requirements of this para-
graph (1) are satisfied if:

(a) during the correction period,
the Plan Sponsor is reasonably prompt in
identifying the Operational Failure, for-
mulating a correction method, and initiat-
ing correction in a manner that demon-
strates a commitment to completing
correction of the Operational Failure as
expeditiously as practicable, and

(b) within 90 days after the last
day of the correction period, the Plan
Sponsor completes correction of the
Operational Failure.

(2) The requirements of this para-
graph (2) are satisfied if:

(a) during the correction period,
correction is completed with respect to 85
percent of all participants affected by the
Operational Failure, and

(b) thereafter, the Plan Sponsor
completes correction of the Operational
Failure with respect to the remaining
affected participants in a diligent manner.

.05 Examples. The following exam-
ples illustrate the application of this sec-
tion 9. Assume that the eligibility require-
ments of section 4 relating to SCP have
been met.

Example 1: Employer Z established a qualified
defined contribution plan in 1986 and received a
favorable determination letter for TRA '86. During
1999, while doing a self-audit of the operation of
the plan for the 1998 plan year, the plan adminis-
trator discovered that, despite the practices and pro-
cedures established by Employer Z with respect to
the plan, several employees eligible to participate
in the plan were excluded from participation. The
administrator also found that for 1998 Operational
Failures occurred because the elective deferrals of
additional employees exceeded the § 402(g) limit
and Employer Z failed to make the required top-
heavy minimum contribution. During the 1999 plan

year, the Plan Sponsor made corrective contribu-
tions on behalf of the excluded employees, distrib-
uted the excess deferrals to the affected partici-
pants, and made a top-heavy minimum contribution
to all participants entitled to that contribution for
the 1999 plan year. Each corrective contribution
and distribution was credited with earnings at a rate
appropriate for the plan from the date the corrective
contribution or distribution should have been made
to the date of correction. Under these facts, the
Plan Sponsor has corrected the Operational
Failures for the 1998 plan year within the correc-
tion period and thus satisfied the requirements of
this section 9.

Example 2: Employer A established a qualified
defined contribution plan, Plan A, in 1990 and
received a favorable determination letter for TRA
'86. In April 2002, Employer A purchased all of the
stock of Employer B, a wholly-owned subsidiary of
Employer C. Employees of Employer B participated
in a qualified defined contribution plan sponsored by
Employer C, Plan C. Following Employer A's
review of Plan C, Employer A and Employer C
agreed that Plan A would accept a transfer of plan
assets attributable to the account balances of the
employees of Employer B who had participated in
Plan C. As part of this agreement, Employer C rep-
resented to Employer A that Plan C is tax qualified.
Employers A and C also agreed that such transfer
would be in accordance with § 414(l) and
§ 1.414(1)-1 and addressed issues related to costs
associated with the transfer. Following the transac-
tion, the employees of Employer B began participa-
tion in Plan A. Effective July 1, 2002, Plan A accept-
ed the transfer of plan assets from Plan C. After the
transfer, Employer A determined that all the partici-
pants in one division of Employer B had been incor-
rectly excluded from allocation of the profit sharing
contributions for the 1998 and 1999 plan years.
During 2003, Employer A made corrective contribu-
tions on behalf of the affected participants. The cor-
rective contributions were credited with earnings at
a rate appropriate for the plan from the date the cor-
rective contribution should have been made to the
date of correction and Employer A otherwise com-
plied with the requirements of SCP. Under these
facts, Employer A has, within the correction period,
corrected the Operational Failures for the 1998 and
1999 plan years with respect to the assets transferred
to Plan A, and thus satisfied the requirements of this
section 9.

# PART V. VOLUNTARY CORRECTION PROGRAM WITH SERVICE APPROVAL (VCP)

## SECTION 10. VCP GENERAL PROCEDURES

.01 VCP requirements. The require-
ments of this section 10 are satisfied with
respect to failures submitted in accor-
dance with the requirements of this sec-
tion 10 if the Plan Sponsor pays the com-
pliance fee required under section 12 and
implements the corrective actions and sat-
isfies any other conditions in the compli-
ance statement described in section 10.07.

.02 Identification of failures. VCP is
not based upon an examination of the plan
by the Service. Only the failures raised by
the Plan Sponsor or failures identified by
the Service in processing the application
will be addressed under the program, and
only those failures will be covered by the
program. The Service will not make any
investigation or finding under VCP con-
cerning whether there are failures.

.03 Effect of VCP submission on
examination. Because VCP does not
arise out of an examination, considera-
tion under VCP does not preclude or
impede (under § 7605(b) or any adminis-
trative provisions adopted by the
Service) a subsequent examination of the
Plan Sponsor or the plan by the Service
with respect to the taxable year (or years)
involved with respect to matters that are
outside the compliance statement.
However, a Plan Sponsor's statements
describing failures are made only for
purposes of VCP and will not be regard-
ed by the Service as an admission of a
failure for purposes of any subsequent
examination.

.04 No concurrent examination activi-
ty. Except in unusual circumstances, a
plan that has been properly submitted
under VCP will not be examined while the
submission is pending. This practice
regarding concurrent examinations does
not extend to other plans of the Plan
Sponsor. Thus, any plan of the Plan
Sponsor that is not pending under VCP
could be subject to examination.

.05 Submission of determination letter
application for plan amendments. In any
case in which correction of a Qualified
Plan failure includes correction of a Plan
Document Failure or correction of an
Operational Failure by plan amendment
as permitted under section 4.06, other
than adoption of an amendment designat-
ed by the Service as a model amendment
or a standardized or prototype plan, the
Plan Sponsor should submit a copy of the
amendment, the appropriate application
form (i.e., Form 5300 series or Form
6406), and the appropriate user fee con-
currently and to the same address as the
VCP submission.

.06 Processing of submission. (1)
Screening of submission. Upon receipt of
a submission under VCP, the Service will
review whether the eligibility require-
ments of section 4 and the submission
requirements of section 11 are satisfied.

If the Service determines that a VCP sub-
mission is seriously deficient, the Service
reserves the right to return the submission,
including any compliance fee, without
contacting the Plan Sponsor.

(2) Review of submission. Once the
Service determines that the submission is
complete under VCP, the Service will
consult with the Plan Sponsor or the Plan
Sponsor's representative to discuss the
proposed corrections and the plan's
administrative procedures.

(3) Additional information required.
If additional information is required, a
Service representative will generally con-
tact the Plan Sponsor or the Plan
Sponsor's representative and explain what
is needed to complete the submission. The
Plan Sponsor will have 21 calendar days
from the date of this contact to provide the
requested information. If the information
is not received within 21 days, the matter
will be closed, the compliance fee will not
be returned, and the case may be referred
to Employee Plans Examinations. Any
request for an extension of the 21-day
time period must be made in writing with-
in the 21-day time period and must be
approved by the Service (by the applica-
ble group manager).

(4) Additional failures discovered
after initial submission. (a) A Plan
Sponsor that discovers additional, unrelat-
ed failures after its initial submission may
request that such failures be added to its
submission. However, the Service retains
the discretion to reject the inclusion of
such failures if the request is not timely,
for example, if the Plan Sponsor makes its
request when processing of the submis-
sion is substantially complete.

(b) If the Service discovers an
unrelated failure while the request is
pending, the failure generally will be
added to the failures under consideration.
However, the Service retains the discre-
tion to determine that a failure is outside
the scope of the voluntary request for con-
sideration because it was not voluntarily
brought forward by the Plan Sponsor. In
this case, if the additional failure is signif-
icant, all aspects of the plan may be exam-
ined and the rules pertaining to Audit
CAP will apply. (See sections 13 and 14.)

(5) Conference right. If the Service
initially determines that it cannot issue a
compliance statement because the parties
cannot agree upon correction or a change

in administrative procedures, the Plan
Sponsor (generally through the Plan
Sponsor's representative) will be contact-
ed by the Service representative and
offered a conference with the Service.
The conference can be held either in per-
son or by telephone, and must be held
within 21 calendar days of the date of
contact. The Plan Sponsor will have 21
calendar days after the date of the confer-
ence to submit additional information in
support of the submission. Any request
for an extension of the 21-day time period
must be made in writing within the 21-day
time period and must be approved by the
Service (by the applicable group manag-
er). Additional conferences may be held
at the discretion of the Service.

(6) Failure to reach resolution. If the
Service and the Plan Sponsor cannot
reach agreement with respect to the sub-
mission, all aspects of the plan may be
examined, and the Service may refer the
submission to Employee Plans
Examinations.

(7) Issuance of compliance state-
ment. If agreement is reached, the Service
will send to the Plan Sponsor an unsigned
compliance statement specifying the cor-
rective action required. Within 30 calen-
dar days of the date the compliance state-
ment is sent, a Plan Sponsor must sign the
compliance statement and return it and
any compliance fee required to be paid at
the time that the compliance statement is
signed (see sections 11.05 and 11.06
regarding timing of payment of compli-
ance fee). The Service will then issue a
signed copy of the compliance statement
to the Plan Sponsor. If the Plan Sponsor
does not send the Service the signed com-
pliance statement (with the compliance
fee) within 30 calendar days, the plan may
be referred to Employee Plans
Examinations for examination considera-
tion.

(8) Timing of correction. The Plan
Sponsor must implement the specific cor-
rections and administrative changes set
forth in the compliance statement within
150 days of the date of the compliance
statement. Any request for an extension
of this time period must be made in
advance and in writing and must be
approved by the Service.

(9) Modification of compliance state-
ment. Once the compliance statement has
been issued (based on the information

provided), the Plan Sponsor cannot
request a modification of the compliance
terms except by a new request for a com-
pliance statement. However, if the
requested modification is minor and is
postmarked no later than 30 days after the
compliance statement is issued, the com-
pliance fee for the modification will be
the lesser of the original compliance fee
or $1,250.

(10) Verification. Once the compli-
ance statement has been issued, the
Service may require verification that the
corrections have been made and that any
plan administrative procedures required
by the statement have been implemented.
This verification does not constitute an
examination of the books and records of
the employer or the plan (within the
meaning of § 7605(b)). If the Service
determines that the Plan Sponsor did not
implement the corrections and procedures
within the stated time period, the plan
may be referred to Employee Plans
Examinations for examination considera-
tion.

.07 Compliance statement. (1)
General description of compliance state-
ment. The compliance statement issued
for a VCP submission addresses the fail-
ures identified, the terms of correction,
including any revision of administrative
procedures, and the time period within
which proposed corrections must be
implemented, including any changes in
administrative procedures. The compli-
ance statement also provides that the
Service will not treat the plan as failing to
satisfy the applicable requirements of the
Code on account of the failures described
in the compliance statement if the condi-
tions of the compliance statement are sat-
isfied. Where current procedures are
inadequate for operating the plan in con-
formance with the applicable require-
ments of the Code, the compliance state-
ment will be conditioned upon the
implementation of stated administrative
procedures. The Service may prescribe
appropriate administrative procedures in
the compliance statement.

(2) Compliance statement condi-
tioned upon timely correction. The com-
pliance statement is conditioned on (i)
there being no misstatement or omission
of material facts in connection with the
submission and (ii) the implementation of
the specific corrections and satisfaction of

any other conditions in the compliance
statement.

(3) Authority delegated. Compliance
statements (including any waiver of the
excise tax under § 4974) are authorized to
be signed by Area Managers reporting to
the Director, Employee Plans Examina-
tions, and managers within Employee
Plans Rulings and Agreements, under the
Tax Exempt and Government Entities
Division of the Service.

.08 Effect of compliance statement
on examination. The compliance state-
ment is binding upon both the Service
and the Plan Sponsor or Eligible
Organization with respect to the specif-
ic tax matters identified therein for the
periods specified, but does not preclude
or impede an examination of the plan by
the Service relating to matters outside
the compliance statement, even with
respect to the same taxable year or years
to which the compliance statement
relates.

.09 Processing of determination letter
applications not submitted under VCP.
(1) The Service may process a determina-
tion letter application submitted under the
determination letter program (including
an application requested on Form 5310)
concurrently with a VCP submission for
the same plan. However, issuance of the
determination letter in response to an
application made on a Form 5310 will be
suspended pending the closure of the VCP
submission.

(2) A submission of a plan under the
determination letter program does not
constitute a submission under VCP. Thus,
a Plan Sponsor that discovers a
Qualification Failure in its plan must
make a separate application under VCP. If
the failure is discovered by the Service in
connection with a determination letter
application, the agent may issue a closing
agreement with respect to the failures
identified or, if appropriate, refer the case
to Employee Plans Examinations. In
either case, the fee structure in section 12,
applicable to VCP, will not apply.
Instead, the fee structure in section 14
relating to Audit CAP will apply. (See sec-
tions 13 and 14.)

.10 Special rules relating to VCO. (1)
Under VCP, Operational Failures in a
Qualified Plan may be corrected under the
VCO rules in this subsection. VCO is
available only if the plan's identified fail-

ures are all Operational Failures and only
if the plan has a Favorable Letter.

(2) If the plan is not the subject of
a Favorable Letter, or if the submission
either includes a failure other than an
Operational Failure or includes an egre-
gious failure described in section 4.09,
the submission will be converted from a
submission under VCO to a submission
under the VCP general procedures. The
compliance fee will be retained and will
be applied to the compliance fee
required under the VCP general proce-
dures. The Service retains the discretion
to determine whether a submission is
outside the scope of the special VCO
rules even if the identified failures are
Operational Failures and the plan has a
Favorable Letter. The discretion will be
applied only in rare and unusual circum-
stances.

(3) Reliance on any compliance
statement issued for a plan initially adopt-
ed or effective after December 7, 1994,
other than an adoption of a master or pro-
totype or regional prototype plan, is con-
ditioned upon the plan being timely sub-
mitted for a determination letter within
the plan's remedial amendment period
under § 401(b).

.11 Special rules relating to VCS. (1)
Under VCO, certain Operational Failures
in a Qualified Plan may be corrected
under the VCS rules in this subsection.
VCS is available only if the plan's only
identified Operational Failures are fail-
ures addressed in Appendix A or
Appendix B of this revenue procedure
and the failures are corrected in accor-
dance with an applicable correction
method set forth in Appendix A or
Appendix B. Appropriate correction
must be made for any Qualification
Failure that results from the application
of a VCS correction.

(2) The correction methods set forth
in Appendix A and Appendix B are strict-
ly construed and are the only acceptable
correction methods for failures corrected
under VCS. If the Plan Sponsor wishes
to modify a correction method provided
in Appendix A or Appendix B or to pro-
pose another method, the Plan Sponsor
may not use VCS, but may request a
compliance statement under the VCO
procedure.

(3) VCS is not available if the Plan
Sponsor has identified more than two

failures in a single VCS request. If there
are one or two failures that can be cor-
rected under VCS and there are other
failures that cannot be corrected under
VCS, VCS is not available. The Service
reserves the right to shift requests for
consideration under VCS into VCO if the
Plan Sponsor submits a second VCS
request with respect to the same plan
while the first VCS request is being con-
sidered or during the 12 months after the
first VCS compliance statement is
issued. Both VCS requests may be shift-
ed into VCO if the first VCS request is
still being considered.

(4) The Service will review a VCS
request within 120 days of the date the
submission is received and determined
to be complete. If the Service deter-
mines that the request is acceptable, the
Service will issue a compliance state-
ment on the Plan Sponsor's proposed
correction.

.12 Special rules relating to
Anonymous (John Doe) Submission
Procedure. (1) The Service has estab-
lished an Anonymous Submission
Procedure that permits submission of a
Qualified or 403(b) Plan under VCP with-
out initially identifying the plan or the
Plan Sponsor. Only failures other than
those addressed in Appendix A and
Appendix B may be submitted under this
procedure. A plan is not eligible for the
Anonymous Submission Procedure with
respect to a failure that was submitted
under the Anonymous Submission
Procedure within the preceding two years.
The requirements of this revenue proce-
dure relating to VCP, including sections
10, 11, and 12, apply to these submis-
sions. However, information identifying
the plan or the Plan Sponsor may be
redacted. Once the Service and the plan
representative reach agreement with
respect to the submission, the Service will
contact the plan representative in writing
indicating the terms of the agreement. The
Plan Sponsor will have 21 calendar days
from the date of the letter of agreement to
identify the plan and Plan Sponsor. If the
Plan Sponsor does not submit the identi-
fying material within 21 calendar days of
the letter of agreement, the matter will be
closed and the compliance fee will not be
returned.

(2) Notwithstanding section 10.04,
until the plan and Plan Sponsor are identi-

fied to the Service, a submission under
this subsection does not preclude or
impede an examination of the Plan
Sponsor or its plan(s). Thus, a plan sub-
mitted under the Anonymous Submission
Procedure that comes Under Examination
prior to the date the plan and Plan Sponsor
identifying materials are received by the
Service will no longer be eligible for
either the Anonymous Submission
Procedure or VCP.

(3) Unless otherwise extended, the
Anonymous Submission Procedure will
not apply to applications submitted after
December 31, 2002.

.13 Special rules relating to VCT. A
VCP submission for a 403(b) Plan is
required to be made under the VCT pro-
cedure. A VCT submission is subject to
the procedures of sections 10 and 11. A
403(b) Plan is not eligible for VCO or
VCS.

.14 Special rules relating to VCGroup.
(1) General rules. An Eligible
Organization may submit a VCP request
for a Qualified Plan or a 403(b) Plan
under the VCGroup procedure under this
subsection and may not submit an appli-
cation under VCO, VCS, VCT, or the
Anonymous Submission Procedure.
VCGroup applies if (a) the failures are
all Operational Failures and the Eligible
Organization is an Eligible Organization
defined in sections 10.14(2)(b) or (c), or
(b) the failures are all Plan Document
Failures and the Eligible Organization is
a Sponsor as defined in section
10.14(2)(a).

(2) Eligible Organizations. For
purposes of VCGroup, the term "Eligible
Organization" means either (a) a
Sponsor (as that term is defined in sec-
tion 4.09 of Rev. Proc. 2000-20 2000-6
I.R.B. 553) of a master or prototype plan
that (i) receives an opinion letter that
considers the provisions of GUST, or (ii)
has received an opinion letter that con-
siders TRA '86 and has been submitted
for a GUST opinion letter by December
31, 2000, (b) an insurance company or
other entity that has issued annuity con-
tracts or provides services with respect
to assets for 403(b) Plans, or (c) an enti-
ty that provides its clients with adminis-
trative services with respect to Qualified
Plans or 403(b) Plans. An Eligible
Organization is not eligible for VCGroup
unless the submission includes a failure

resulting from a systemic error involving
the Eligible Organization that affects at
least 20 plans. If, at any time before the
Service provides an unsigned compli-
ance statement, the number of plans that
have the same failure falls below 20, the
Eligible Organization must notify the
Service that it is no longer eligible for
VCGroup (and the compliance fee will
be retained).

(3) Special VCGroup procedures.
(a) A VCGroup submission is subject to
the same procedures as any VCP submis-
sion in accordance with sections 10 and
11, except that the Eligible Organization
is responsible for performing the proce-
dural obligations imposed on the Plan
Sponsor under sections 10 and 11.

(b) When an Eligible
Organization under VCGroup receives
an unsigned compliance statement on the
proposed correction and agrees to the
terms of the compliance statement, the
Eligible Organization must return to the
Service within 120 calendar days not
only the signed compliance statement
and any additional compliance fee under
section 12.06, but also a list containing
(i) the employers' tax identification num-
bers for the Plan Sponsors of the plans to
whom the compliance statement may be
applicable and (ii) the plans by name,
plan number, type of plan, number of
plan participants, and trust's tax identifi-
cation numbers, if applicable, along with
(iii) a power of attorney (which may be a
limited power of attorney) from each of
the Plan Sponsors authorizing the
Eligible Organization or its representa-
tive to act on the Plan Sponsor's behalf
with respect to the items in the compli-
ance statement and (iv) a copy of the
most recently filed Form 5500 series
return for each plan. Only those plans for
which correction is actually made within
240 calendar days of the date of the
signed compliance statement (or within
such longer period as may be agreed to
by the Service at the request of the
Eligible Organization) will be covered
by that statement.

(c) Notwithstanding section 10.04,
until the Eligible Organization provides
the Service with the information of sec-
tion 10.14(3)(b)(i) through (iv) with
respect to a Plan Sponsor and its plan(s), a
VCGroup submission does not preclude
or impede an examination of the Plan

Sponsor or its plan(s).

(4) VCGroup implementation. The
VCGroup procedure is being implement-
ed on a provisional basis, and the Service
and Treasury invite comments on the
operation of the VCGroup procedure.
While the Anonymous Submission
Procedure is not available in connection
with the VCGroup procedure, Eligible
Organizations that are considering filing a
VCGroup submission may, of course, dis-
cuss the submission with the Service on
an anonymous basis before filing the
VCGroup submission.

.15 Special rules relating to VCSEP. A
VCP submission for a SEP is required to
be made under the VCSEP procedure. A
VCSEP submission is subject to the pro-
cedures of sections 10 and 11. A SEP Plan
is not eligible for VCO or VCS.

.16 Multiemployer and multiple
employer plans. (1) In the case of a mul-
tiemployer or multiple employer plan, the
plan administrator (rather than any con-
tributing or adopting employer) must
request consideration of the plan under
the programs. The request must be with
respect to the plan, rather than a portion
of the plan affecting any particular
employer.

(2) If a VCP submission for a multi-
employer or multiple employer plan has
failures that apply to fewer than all of the
employers under the plan, the plan admin-
istrator may choose to have the compli-
ance fee (in section 12) or sanction (in
section 14) calculated separately for each
employer based on the assets attributable
to that employer, rather than being attrib-
utable to the assets of the entire plan.
Thus, the plan administrator may choose
to apply the provisions of this paragraph
where the failure is attributable in whole
or in part to data, information, actions, or
inactions that are within the control of the
employers rather than the multiemployer
or multiple employer plan (such as attri-
bution in whole or in part to the failure of
a employer to provide the plan adminis-
trator with full and complete informa-
tion).

SECTION 11. APPLICATION
PROCEDURES FOR VCP

.01 General rules. The requirements
of this section 11 are satisfied if the
request for a compliance statement from
the Service under VCP satisfies the infor-

mational and other requirements of this
section 11. In general, a request under
VCP consists of a letter from the Plan
Sponsor (which may be a letter from the
Plan Sponsor's representative) to the
Service that contains a description of the
failures, a description of the proposed
methods of correction, and other proce-
dural items, and includes supporting
information and documentation as
described below.

.02 Submission requirements. The let-
ter from the Plan Sponsor or the Plan
Sponsor's representative must contain the
following:

(1) A complete description of the
failures and the years in which the failures
occurred, including closed years (that is,
years for which the statutory period has
expired).

(2) A description of the administra-
tive procedures in effect at the time the
failures occurred.

(3) An explanation of how and why
the failures arose.

(4) A detailed description of the
method for correcting the failures that
the Plan Sponsor has implemented or
proposes to implement. Each step of the
correction method must be described in
narrative form. The description must
include the specific information needed
to support the suggested correction
method. This information includes, for
example, the number of employees
affected and the expected cost of correc-
tion (both of which may be approximat-
ed if the exact number cannot be deter-
mined at the time of the request), the
years involved, and calculations or
assumptions the Plan Sponsor used to
determine the amounts needed for cor-
rection. See section 10.11 for special
procedures regarding VCS.

(5) A description of the methodolo-
gy that will be used to calculate earnings
or actuarial adjustments on any corrective
contributions or distributions (indicating
the computation periods and the basis for
determining earnings or actuarial adjust-
ments, in accordance with section
6.02(4)).

(6) Specific calculations for each
affected employee or a representative
sample of affected employees. The sam-
ple calculations must be sufficient to
demonstrate each aspect of the correction
method proposed. For example, if a Plan

Sponsor requests a compliance statement
with respect to a failure to satisfy the
contribution limits of § 415(c) and pro-
poses a correction method that involves
elective contributions (whether matched
or unmatched) and matching contribu-
tions, the Plan Sponsor must submit cal-
culations illustrating the correction
method proposed with respect to each
type of contribution. As another exam-
ple, with respect to a failure to satisfy the
ADP test in § 401(k)(3), the Plan
Sponsor must submit the ADP test results
both before the correction and after the
correction.

(7) The method that will be used to
locate and notify former employees and
beneficiaries, or an affirmative statement
that no former employees or beneficiaries
were affected by the failures or will be
affected by the correction.

(8) A description of the measures that
have been or will be implemented to ensure
that the same failures will not recur.

(9) A statement that, to the best of
the Plan Sponsor's knowledge, neither the
plan nor the Plan Sponsor is Under
Examination.

(10) If a submission includes a fail-
ure that refers to Transferred Assets and
occurred prior to the transfer, a descrip-
tion of the transaction (including the dates
of the employer change and the plan
transfer).

.03 Submission requirements under
special procedures. The letter from the
Plan Sponsor or the Plan Sponsor's repre-
sentative must also contain the following:

(1) VCO. In the case of a VCO sub-
mission, a statement (if applicable) that
the plan is currently being considered in a
determination letter application. If the
request for a determination letter is made
while a request for consideration under
VCO is pending, the Plan Sponsor must
update the VCO request to add this infor-
mation.

(2) VCS. In the case of a VCS sub-
mission, a statement that it is a VCS
request, a description of the applicable
correction in accordance with Appendix A
or Appendix B, and a statement that the
Plan Sponsor proposes to implement (or
has implemented) the correction(s).

(3) VCT. In the case of a VCT sub-
mission, a statement that the Plan Sponsor
has contacted all other entities involved
with the plan and has been assured of

cooperation in implementing the applica-
ble correction, to the extent necessary.
For example, if the plan's failure is the
failure to satisfy the requirements of
§ 403(b)(1)(E) on elective deferrals, the
Plan Sponsor must, prior to making the
VCT application, contact the insurance
company or custodian with control over
the plan's assets to assure cooperation in
effecting a distribution of the excess
deferrals and the earnings thereon. An
application under VCT must also contain
a statement as to the type of employer
(e.g., a tax-exempt organization described
in § 501(c)(3)) submitting the VCT appli-
cation.

(4) Anonymous Submission. In the
case of an Anonymous Submission, a
statement that the plan has not used the
Anonymous Submission Procedure in the
preceding two years with respect to the
failures included in the submission.

(5) VCGroup. A VCGroup submis-
sion must be signed by the Eligible
Organization or the Eligible Organiza-
tion's authorized representative and
accompanied by a copy of the relevant
portions of the plan document(s).

(6) VCSEP. In the case of an VCSEP
submission, a statement that it is a VCSEP
request, a description of the applicable
correction, and a statement that the Plan
Sponsor proposes to implement (or has
implemented) the correction(s).

.04 Required documents. A VCP sub-
mission must be accompanied by the fol-
lowing documents:

(1) Form 5500 or similar informa-
tion. (a) VCP. In the case of the general
procedures under VCP, a copy of the most
recently filed Form 5500 series return.

(b) VCO and VCS. In the case of
a VCO or VCS submission, a copy of the
first page and a copy of the page contain-
ing employee census information (cur-
rently, line 7f of the 1999 Form 5500) and
a copy of the page containing the total
amount of plan assets (currently, line 31f
of the 1999 Form 5500) or the most
recently filed Form 5500 series return.

(c) Anonymous submission. In the
case of a submission under the
Anonymous Submission Procedure, the
employee census and plan asset informa-
tion may be redacted and replaced by
numbers that are rounded up.

(d) VCT. In the case of a VCT
submission, if Form 5500 is inapplicable,

the information generally included on the
first two pages of Form 5500, including
the name and number of the plan, and the
employer's Employer Identification
Number.

(e) VCSEP. In the case of a
VCSEP submission, if Form 5500 is inap-
plicable, the information generally includ-
ed on the first two pages of Form 5500,
including the name and number of the
plan, and the employer's Employer
Identification Number.

(2) Plan document. A copy of the
relevant portions of the plan document.
For example, in a case involving improp-
er exclusion of eligible employees from a
profit-sharing plan with a cash or deferred
arrangement, relevant portions of the plan
document include the eligibility, alloca-
tion, and cash or deferred arrangement
provisions of the basic plan document
(and the adoption agreement, if applica-
ble), along with applicable definitions in
the plan. If the plan is a 403(b) Plan and
a plan document is not available, written
descriptions of the plan, and sample salary
reduction agreements if relevant. In the
case of a SEP, submit the entire plan doc-
ument.

(3) Determination letter applica-
tion. In any case in which correction of a
Qualified Plan failure includes correc-
tion of a Plan Document Failure or cor-
rection of an Operational Failure by plan
amendment as permitted under section
4.06, other than adoption of an amend-
ment designated by the Service as a
model amendment or a standardized or
prototype plan, the Plan Sponsor must
submit the amendment, the appropriate
application form (i.e., Form 5300 series
or Form 6406), and the appropriate user
fee.

(4) Copy of Favorable Letter for
VCO, VCS, or VCSEP. In the case of
VCO, VCS, or VCSEP, a copy of the
determination letter, opinion letter, or
notification letter that considered TRA
'86, except:

(a) a governmental plan, or a non-
electing church plan described in Rev.
Proc. 99-23 for which the TRA '86

remedial amendment period has not yet
expired should submit a copy of the
determination, opinion, or notification
letter that considered TEFRA, DEFRA,
and REA and a statement that explains
the reason why the period has not yet
expired,

(b) plans initially adopted or effec-
tive after December 7, 1994 should sub-
mit a statement that the plan will be sub-
mitted timely for a determination,
opinion, or notification letter within the
plan's remedial amendment period under
§ 401(b), and

(c) in the case of a SEP, a copy of
the most recent opinion letter for a proto-
type SEP, a copy of the current model SEP
on Form 5305-SEP or 5305A-SEP, a
copy of the private letter ruling issued to
an individually designed SEP.

.05 Date VCP fee due generally.
Except as provided in section 11.06, the
VCP fee under section 12 is due at the
time the compliance statement is signed
by the Plan Sponsor and returned to the
Service.

.06 Fee due earlier for VCO, VCS,
Anonymous Submission, VCGroup, and
VCSEP. In the case of a VCO or VCS
submission, the appropriate fee
described in section 12.02 or 12.03 must
be included with the submission. In the
case of a submission made under the
Anonymous Submission Procedure,
VCGroup, or VCSEP, the initial fee
described in section 12.04(1), 12.06, or
12.07(1), respectively, must be included
with the submission (and any additional
fee is due at the time provided in section
11.05).

.07 Signed submission. The submis-
sion must be signed by the Plan Sponsor
or the sponsor's authorized representa-
tive.

.08 Power of attorney requirements.
To sign the submission or to appear
before the Service in connection with
the submission, the Plan Sponsor's rep-
resentative must comply with the
requirements of section 9.02(11) and
(12) of Rev. Proc. 2001-4, 2001-1
I.R.B. 121.

.09 Penalty of perjury statement.
The following declaration must accom-
pany a request and any factual informa-
tion or change in the submission at a
later time: "Under penalties of per-
jury, I declare that I have examined
this submission, including accompa-
nying documents, and, to the best of
my knowledge and belief, the facts
presented in support of this submis-
sion are true, correct, and complete."
The declaration must be signed by the
Plan Sponsor, not the Plan Sponsor's
representative.

.10 Checklist. The Service will be
able to respond more quickly to a VCP
request if the request is carefully pre-
pared and complete. The checklist in
Appendix C is designed to assist Plan
Sponsors and their representatives in
preparing a submission that contains the
information and documents required
under this revenue procedure. The
checklist in Appendix C must be com-
pleted, signed, and dated by the Plan
Sponsor or the Plan Sponsor's represen-
tative, and should be placed on top of the
submission. A photocopy of this check-
list may be used.

.11 Designation. The letter to the
Service should be designated "VCP",
"VCO", "VCS", "VCT", "VCSEP", or
"VCGroup", as appropriate, in the upper
right hand corner of the letter. In addition
if the submission is an Anonymous
Submission, the letter should also be des-
ignated "Anonymous Submission
Procedure".

.12 VCP mailing address. Submissions
under VCO (and any VCO submission
under the Anonymous Submission
Procedure), VCGroup, and VCSEP should
be mailed to:

Internal Revenue Service

Attention: T:EP:RA:VC
P.O. Box 27063
McPherson Station
Washington, D.C. 20038

All other VCP submissions should be
mailed to:

If the entity is in:

the application should be sent to:

Connecticut, Maine,

Employee Plans VCP

Massachusetts, Michigan,

Internal Revenue Service

New Hampshire, New Jersey,

10 Metro Tech Center

New York, Ohio, Pennsylvania,

625 Fulton Street

Rhode Island, Vermont

Brooklyn, NY 11201 Phone (718) 488-2372 FAX (718) 488-2405

Alabama, Delaware, District of

Employee Plans VCP

Columbia, Florida, Georgia,

Internal Revenue Service

Indiana, Kentucky, Louisiana,

Room 1550

Maryland, Mississippi, North

P.O. Box 13163

Carolina, South Carolina,

Baltimore, MD 21203

Tennessee, Virginia, West

Phone (410) 962-3499

Virginia, any U.S. possession

FAX (410) 962-0882

or foreign country

Arkansas, Illinois, Iowa,

Employee Plans VCP

Kansas, Minnesota, Missouri,

Internal Revenue Service

Nebraska, North Dakota,

230 S. Dearborn

Oklahoma, South Dakota, Texas,

MC 4913 Chi

Wisconsin

Chicago, IL 60604 Phone (312) 886-1277 FAX (312) 886-2386

Alaska, Arizona, California,

Employee Plans VCP

Colorado, Hawaii, Idaho,

Internal Revenue Service

Montana, Nevada, New Mexico,

2 Cupania Circle

Oregon, Utah, Washington, Wyoming

Monterey Park, CA 91755-7431 Phone (323) 869-3905 FAX (323) 869-3949

.13 Maintenance of copies of submis-
sions. Plan Sponsors and their representa-
tives should maintain copies of all corre-
spondence submitted to the Service with
respect to their VCP requests.

SECTION 12. VCP FEES

.01 VCP general procedure compli-
ance fee. (1) Compliance fee chart.

Except as otherwise provided in this sec-
tion 12, the compliance fee for an applica-
tion under VCP is determined in accor-
dance with the chart below. The chart
contains a graduated range of fees based
on the size of the plan and the number of
participants. Each range includes a mini-
mum amount, a maximum amount, and a
presumptive amount. In each case, the

minimum amount is the applicable VCO
fee in section 12.02. It is expected that in
most instances the compliance fee
imposed will be at or near the presumptive
amount in each range; however, the fee
may be a higher or lower amount within
the range, depending on the factors in
paragraph (2) below.

VCP GENERAL PROCEDURES COMPLIANCE FEES

# of participants

Fee range

Presumptive Amount

10 or fewer

VCO fee* to $4,000

$2,000

11 to 50

VCO fee* to $8,000

$4,000

51 to 100

VCO fee* to $12,000

$6,000

101 to 300

VCO fee* to $16,000

$8,000

301 to 1,000

VCO fee* to $30,000

$15,000

Over 1,000

VCO fee* to $70,000

$35,000

\* Items marked by asterisk refer to the VCO compliance fee that would apply under section 12.02 if the plan had been submitted
under VCO.

(2) Factors considered. Except as
provided in section 12.01(3) with
respect to nonamenders and section
12.01(4) relating to egregious failures,
consideration of whether the compliance
fee should be equal to, greater than, or
less than the presumptive amount will
depend on factors relating to the nature,
extent, and severity of the failure. These
factors include: (a) whether the failure is
a failure to satisfy the requirements of
§ 401(a)(4), § 401(a)(26), or § 410(b),
(b) whether the plan has both
Operational and Plan Document
Failures, (c) the period over which the
violation occurred (for example, the
time that has elapsed since the end of the
applicable remedial amendment period
under § 401(b) for a Plan Document
Failure), (d) the extent to which the plan
has accepted Transferred Assets, and the
extent to which the failures relate to the
Transferred Assets and occurred before
the transfer, and (e) whether the plan has
a Favorable Letter.

(3) VCP fee for nonamenders.
Except in rare and unusual circum-
stances, the VCP compliance fee for a
submission that includes only a Plan
Document Failure that is solely a failure
to amend the plan timely to comply with
required tax law changes is determined
in accordance with section 12.01(1), as
follows.

(a) UCA or OBRA '93 model
amendments only - the fee is the halfway
point between the minimum amount and
the presumptive amount of the applicable
fee range.

(b) TRA '86 - the fee is the pre-
sumptive amount of the applicable fee
range, and clause (a) does not apply.

(c) TEFRA, DEFRA, or REA -
the fee is the halfway point between the
presumptive amount and the maximum
amount of the applicable fee range, and
clauses (a) and (b) do not apply.

(d) ERISA - the fee is the maxi-
mum amount of the applicable fee range,
and clauses (a), (b), and (c) do not apply.

(4) Egregious failures. In cases
involving failures that are egregious (as
described in section 4.09), (a) the maxi-
mum compliance fee applicable to the

plan under the chart in 12.01(1) is
increased to 40 percent of the Maximum
Payment Amount and (b) no presumptive
amount applies.

.02 VCO fee. (1) VCO fee generally.
Unless VCS is applicable, the VCO com-
pliance fee depends on the assets of the
plan and the number of plan participants.

(a) The fee for a plan with assets
of less than $500,000 and no more than
1,000 plan participants is $500.

(b) The fee for a plan with assets
of at least $500,000 and no more than
1,000 plan participants is $1,250.

(d) The fee for a plan with 10,000
or more plan participants is $10,000.

(2) Rev. Proc. 2001-8 modified. The
VCO, Anonymous Submission Proce-
dure, VCGroup, and VCSEP compliance
fee is processed under the user fee pro-
gram described in Rev. Proc. 2001-8,
2001-1 I.R.B. 239.

.03 VCS fee. The VCS compliance fee
is $350.

.04 Fee for Anonymous Submission.
The compliance fee for the Anonymous
Submission Procedure is the fee applica-
ble under other provisions of this section
12 (i.e., the fee under section 12.01 for
VCP general procedures, the fee under
section 12.02 for VCO, or the fee under
section 12.05 for VCT).

(1) The initial portion of the fee is
the amount determined under section
12.02 (for the VCP general procedures or
VCO) or 12.05(2) (for VCT).

(2) The additional fee, if any, is the
fee determined under section 12.01 or
12.05, if applicable, reduced by the fee in
section 12.04(1).

.05 VCT Fee. (1) VCT compliance fee.
The applicable VCT compliance fee
depends on the type of failure and, gener-
ally, the number of employees of the
employer.

(2) Fee for Operational Failures.
Subject to section 12.05(3), the compli-
ance fee for submissions that include only
Operational Failures is as follows:

(a) The fee for an employer with
fewer than 25 employees is $500.

(b) The fee for an employer with at
least 25 and no more than 1,000 employ-
ees is $1,250.

(d) The fee for an employer with
10,000 or more employees is $10,000.

(3) Fee for certain Excess Amounts.
Subject to section 12.05(6), the compli-
ance fee for Excess Amounts that are cor-
rected pursuant to section 6.05(2)(b) is
equal to the sum of (a) the applicable fee
described in section 12.05(2), plus (b) two
percent of the Excess Amounts, adjusted
for earnings through the date of the VCT
application, contributed or allocated in the
calendar year of the VCT application and
in the three calendar years prior thereto. If
there is a failure to satisfy both the
§ 403(b)(2) and § 415 limits with respect
to a single employee for a year, the fee
will take into account only the larger
Excess Amount.

(4) Fee for Demographic and
Eligibility Failures. (a) Subject to section
12.05(6), the compliance fee for a 403(b)
Plan with failures that include any
Demographic or Employer Eligibility
Failure is determined in accordance with
the VCP fee table in section 12.01(1),
except that (i) the reference to VCO fees
is changed to refer to the VCT compliance
fee for Operational Failures in section
12.05(2) above and (ii) the fee is deter-
mined with reference to the number of
employees rather than participants.

(b) In addition to the types of fac-
tors listed in section 12.01(2), factors con-
sidered in determining the compliance fee
for failures that include any Demographic
or Employer Eligibility Failure under VCT
include: (i) whether the failures include a
Demographic Failure, (ii) whether the
403(b) Plan has a combination of two or
more types of failures (Operational,
Demographic, and Employer Eligibility);
and (iii) the period of time over which the
failure occurred.

(5) Fee for multiple failures. If
correction is requested for multiple
failures, the compliance fee is deter-
mined in accordance with the table
below.

Multiple Operational Failures

Fee described in section 12.05(2)

Multiple Demographic or Eligibility Failures

Fee described in section 12.05(4)

Combination of Operational and Demographic or Eligibility Failures

Fee described in section 12.05(4)

Operational Failure(s) with section 6.05(2)(b) correction of Excess Amounts

Fee described in section 12.05(3)

Demographic or Eligibility Failures and Operational Failures including section 6.05(2)(b) correction of Excess Amounts

Fee described in section 12.05(3), substituting section 12.05(4) fee for section 12.05(2) fee

(6) Fee for egregious failures. In
cases involving failures that are egre-
gious, the maximum VCT compliance fee
applicable to the plan is increased to 40
percent of the Total Sanction Amount and
no presumptive amount applies.

.06 VCGroup fees. The compliance fee
for a VCGroup submission is based on the
number of plans to which the compliance
statement is applicable. The initial fee is
$10,000. In the case of a submission with
only corrections under Appendix A or B,
an additional fee is due equal to the prod-
uct of the number of plans in excess of 20
times $125, up to a maximum of $40,000;
in any other case, the additional fee is
equal to the product of the number of
plans in excess of 20 times $250, up to a
maximum of $90,000.

.07 VCSEP fees. The applicable
VCSEP compliance fee is the same as the
fee for VCP in section 12.01, subject to
the following:

(1) In the case of a SEP with
Operational Failures only, the compliance
fee is determined in accordance with the
VCO fee schedule in section 12.02,
except that the fee is determined solely on
the basis of the number of plan partici-
pants.

(2) In any case in which a SEP cor-
rection is not similar to a correction for a
similar Qualification Failure (as provided
under section 6.08(1)), the Service may
impose an additional fee.

.08 Establishing amount of assets and
number of plan participants. Compliance
fees under this section 12 are calculated
by the Plan Sponsor using the numbers
from the most recently filed Form 5500
series to establish the fee. Thus, with
respect to the 1999 Form 5500, the Plan
Sponsor would use the number shown on
line 7(f) (or the equivalent line on the
Form 5500 C/R or EZ) to establish the
number of plan participants and would

use line 31(f) (or the equivalent line on
the Form 5500 C/R or EZ) to establish
the amount of plan assets. If the submis-
sion involves a plan with Transferred
Assets and the Service determines that
none of the failures in the submission
occurred after the end of the second plan
year that begins after the corporate merg-
er, acquisition or other similar employer
transaction, the Plan Sponsor may calcu-
late the amount of plan assets and num-
ber of plan participants based on the
Form 5500 information that would have
been filed by the Plan Sponsor for the
plan year that includes the employer
transaction if the Transferred Assets
were maintained as a separate plan. In
the case of a SEP not required to file a
Form 5500, the Plan Sponsor may use
other reasonable information to deter-
mine the amount of plan assets and the
number of participants.

## PART VI. CORRECTION ON AUDIT (AUDIT CAP)

## SECTION 13. DESCRIPTION OF AUDIT CAP

.01 Audit CAP requirements. If the
Service identifies a failure (other than a
failure that has been corrected in accor-
dance with SCP or VCP) upon an
Employee Plans or Exempt Organizations
examination of a Qualified Plan, 403(b)
Plan, or SEP, the requirements of this sec-
tion 13 are satisfied with respect to the
failure if the Plan Sponsor corrects the
failure, pays a sanction in accordance
with section 14, satisfies any additional
requirements of section 13.03, and enters
into a closing agreement with the Service.

.02 Payment of sanction. Payment of
the sanction under section 14 generally is
required at the time the closing agreement
is signed.

.03
Additional requirements.
Depending on the nature of the failure,
the Service will discuss the appropriate-
ness of the plan's existing administrative
procedures with the Plan Sponsor. If
existing administrative procedures are
inadequate for operating the plan in con-
formance with the applicable require-
ments of the Code, the closing agree-
ment may be conditioned upon the
implementation of stated procedures. In
addition, for Qualified Plans, the Plan
Sponsor may be required to obtain a
Favorable Letter before the closing
agreement is signed unless the Service
determines that it is unnecessary based
on the facts and circumstances (for
example, because the plan already has a
Favorable Letter and no significant
amendments are adopted). If a
Favorable Letter is required, the Plan
Sponsor is required to pay the applicable
user fee for obtaining the letter.

.04 Failure to reach resolution. If the
Service and the Plan Sponsor cannot
reach an agreement with respect to the
correction of the failure(s) or the amount
of the sanction, the plan will be disquali-
fied or, in the case of a 403(b) Plan or
SEP, will not have reliance on this rev-
enue procedure.

.05 Effect of closing agreement. A
closing agreement constitutes an agree-
ment between the Service and the Plan
Sponsor that is binding with respect to the
tax matters identified therein for the peri-
ods specified.

.06 Other procedural rules. The pro-
cedural rules for Audit CAP are set forth
in Internal Revenue Manual ("IRM")
7.9.2, EPCRS.

# SECTION 14. AUDIT CAP SANCTION

.01 Determination of sanction. The
sanction under Audit CAP is a negotiated

percentage of the Maximum Payment
Amount. For 403(b) Plans and SEPs, the
sanction is a negotiated percentage of the
Total Sanction Amount. Sanctions will not
be excessive and will bear a reasonable
relationship to the nature, extent, and
severity of the failures, based on the fac-
tors below.

.02 Factors considered. Factors
include: (1) the steps taken by the Plan
Sponsor to ensure that the plan either had
no failures or corrected them through SCP
or VCP, including the extent to which cor-
rection had progressed before the exami-
nation was initiated, (2) the amount of the
fee the Plan Sponsor would have paid
under section 12 for correcting the fail-
ures, (3) the number and type of employ-
ees affected by the failure, (4) the number
of nonhighly compensated employees
who would be adversely affected if the
plan were not treated as qualified or as
satisfying the requirements of § 403(b) or
§ 408(k), (5) whether the failure is a fail-
ure to satisfy the requirements of
§ 401(a)(4), § 401(a)(26), or § 410(b),
either directly or through § 403(b)(12), (6)
the period over which the failure occurred
(for example, the time that has elapsed
since the end of the applicable remedial
amendment period under § 401(b) for a
Plan Document Failure), and (7) the rea-
son for the failure (for example, data
errors such as errors in transcription of
data, the transposition of numbers, or
minor arithmetic errors). Factors relating
only to Qualified Plans also include: (1)
whether the plan is the subject of a
Favorable Letter, (2) whether the plan has
both Operational and other failures, and
(3) the extent to which the plan has
accepted Transferred Assets, and the
extent to which failures relate to
Transferred Assets and occurred before
the transfer. Additional factors relating
only to 403(b) Plans include: (1) whether
the plan has a combination of Operational,
Demographic, or Employer Eligibility
Failures, (2) the extent to which the fail-
ure relates to Excess Amounts, and (3)
whether the failure is solely an Employer
Eligibility Failure.

.03 Transferred Assets. If the exami-
nation involves a plan with Transferred
Assets and the Service determines that the
failures did not occur after the end of the
second plan year that begins after the cor-

porate merger, acquisition, or other simi-
lar employer transaction occurred, the
sanction under Audit CAP will not exceed
the sanction that would apply if the
Transferred Assets were maintained as a
separate plan.

## PART VII. EFFECT ON OTHER DOCUMENTS; EFFECTIVE DATE; PAPERWORK REDUCTION ACT

## SECTION 15. EFFECT ON OTHER DOCUMENTS

.01 Revenue procedure 2000-16 modi-
fied and superseded. Rev. Proc. 2000-16
is modified and superseded by this rev-
enue procedure.

.02 Rev. Proc. 2001-8 modified. Rev.
Proc. 2001-8 is modified as provided in
section 12.

## SECTION 16. EFFECTIVE DATE

This revenue procedure is generally
effective May 1, 2001. In addition, Plan
Sponsors and Eligible Organizations are
permitted, at their option, to apply the
provisions of this revenue procedure on or
after January 19, 2001 (the release date of
this revenue procedure). Unless a Plan
Sponsor or Eligible Organization applies
this revenue procedure earlier, this rev-
enue procedure is effective:

(1) with respect to SCP, for failures
for which correction is not complete
before May 1, 2001.

(2) with respect to VCP, for applica-
tions submitted on or after May 1, 2001;
and

(3) with respect to Audit CAP, for
examinations begun on or after May 1,
2001.

## SECTION 17. PAPERWORK REDUCTION ACT

The collection of information contained
in this revenue procedure has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545-1673.

An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.

The collection of information in this
revenue procedure is in sections 4.06,
6.02(5)(c), 6.05, 10.01, 10.02,
10.05-10.07, 11.02-11.04, 11.07-11.13,
13.01, section 2.01-2.07 of Appendix B,
and Appendix C. This information is
required to enable the Commissioner, Tax
Exempt and Government Entities
Division of the Internal Revenue Service
to make determinations regarding the
issuance of various types of closing agree-
ments and compliance statements. This
information will be used to issue closing
agreements and compliance statements to
allow individual plans to continue to
maintain their tax qualified and tax-
deferred status. As a result, favorable tax
treatment of the benefits of the eligible
employees is retained. The likely respon-
dents are individuals, state or local gov-
ernments, businesses or other for-profit
institutions, nonprofit institutions, and
small businesses or organizations.

The estimated total annual reporting
and/or recordkeeping burden is 56,272
hours.

The estimated annual burden per
respondent/recordkeeper varies from .5 to
42.5 hours, depending on individual cir-
cumstances, with an estimated average of
113.11 hours. The estimated number of
respondents and/or recordkeepers is
4,292.

The estimated frequency of responses
is occasional.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. § 6103.

## DRAFTING INFORMATION

The principal authors of this revenue
procedure are Maxine Terry and Carlton
Watkins of the Tax Exempt and
Government Entities Division. For fur-
ther information concerning this revenue
procedure, please contact Employee Plans
taxpayer assistance telephone service
between 1:30 and 3:30 p.m., Eastern
Time, Monday through Thursday at (202)
283-9516/9517. (These telephone num-
bers are not toll-free numbers.) Ms. Terry
and Mr. Watkins may be reached at (202)
283-9888 (also not a toll-free number).

# APPENDIX A

## OPERATIONAL FAILURES AND CORRECTIONS UNDER VCS

.01 General rule. This appendix sets
forth Operational Failures relating to
Qualified Plans and corrections under
VCS in accordance with section 10.11. In
each case, the method described corrects
the Operational Failure identified in the
headings below. Corrective allocations
and distributions should reflect earnings
and actuarial adjustments in accordance
with section 6.02(4). The correction
methods in this appendix are acceptable
under SCP and VCP (including VCS).
Additionally, the correction methods and
the earnings adjustment methods in
Appendix B are acceptable under SCP and
VCP (including VCS but not VCT).

.02 Failure to properly provide the
minimum top-heavy benefit under § 416 of
the Code to non-key employees. In a
defined contribution plan, the permitted
correction method is to properly con-
tribute and allocate the required top-heavy
minimums to the plan in the manner pro-
vided for in the plan on behalf of the non-
key employees (and any other employees
required to receive top-heavy allocations
under the plan). In a defined benefit plan,
the minimum required benefit must be
accrued in the manner provided in the
plan.

.03 Failure to satisfy the ADP test set
forth in § 401(k)(3), the ACP test set forth
in § 401(m)(2), or the multiple use test of
§ 401(m)(9). The permitted correction
method is to make qualified nonelective
contributions (QNCs) (as defined in
§ 1.401(k)-1(g)(13)(ii)) on behalf of the
nonhighly compensated employees to the
extent necessary to raise the actual defer-
ral percentage or actual contribution per-
centage of the nonhighly compensated
employees to the percentage needed to
pass the test or tests. The contributions
must be made on behalf of all eligible
nonhighly compensated employees (to the
extent permitted under § 415) and must
either be the same flat dollar amount or
the same percentage of compensation.
QNCs contributed to satisfy the ADP test
need not be matched. Employees who
would have been eligible for a matching
contribution had they made elective con-
tributions must be counted as eligible
employees for the ACP test, and the plan

must satisfy the ACP test. Under this
VCS correction method, a plan may not
be treated as two separate plans, one cov-
ering otherwise excludable employees
and the other covering all other employ-
ees (as permitted in § 1.410(b)-6(b)(3))
in order to reduce the number of employ-
ees eligible to receive QNCs. Likewise,
under this VCS correction method, the
plan may not be restructured into compo-
nent plans (as permitted in
§ 1.401(k)-1(h)(3)(iii) for plan years
before January 1, 1992) in order to reduce
the number of employees eligible to
receive QNCs.

.04 Failure to distribute elective defer-
rals in excess of the § 402(g) limit (in
contravention of § 401(a)(30)). The per-
mitted correction method is to distribute
the excess deferral to the employee and to
report the amount as taxable in the year of
deferral and in the year distributed. In
accordance with § 1.402(g)-1(e)(1)(ii), a
distribution to a highly compensated
employee is included in the ADP test; a
distribution to a nonhighly compensated
employee is not included in the ADP test.

.05 Exclusion of an eligible employee
from all contributions or accruals under
the plan for one or more plan years. The
permitted correction method is to make a
contribution to the plan on behalf of the
employees excluded from a defined con-
tribution plan or to provide benefit accru-
als for the employees excluded from a
defined benefit plan. If the employee
should have been eligible to make an elec-
tive contribution under a cash or deferred
arrangement, the employer must make a
QNC to the plan on behalf of the employ-
ee that is equal to the actual deferral per-
centage for the employee's group (either
highly compensated or nonhighly com-
pensated). If the employee should have
been eligible to make employee contribu-
tions or for matching contributions (on
either elective contributions or employee
contributions), the employer must make a
QNC to the plan on behalf of the employ-
ee that is equal to the actual contribution
percentage for the employee's group
(either highly compensated or nonhighly
compensated). Contributing the actual
deferral or contribution percentage for
such employees eliminates the need to
rerun the ADP or ACP test to account for
the previously excluded employees.
Under this VCS correction method, a plan

may not be treated as two separate plans,
one covering otherwise excludable
employees and the other covering all
other employees (as permitted in
§ 1.410(b)-6(b)(3)) in order to reduce the
amount of QNCs. Likewise, restructuring
the plan into component plans under
§ 1.401(k)-1(h)(3)(iii) is not permitted in
order to reduce the amount of QNCs.

.06 Failure to timely pay the minimum
distribution required under § 401(a)(9).
In a defined contribution plan, the permit-
ted correction method is to distribute the
required minimum distributions. The
amount to be distributed for each year in
which the failure occurred should be
determined by dividing the adjusted
account balance on the applicable valua-
tion date by the applicable divisor. For
this purpose, adjusted account balance
means the actual account balance, deter-
mined in accordance with § 1.401(a)(9)-1
Q&A F-5 of the proposed regulations,
reduced by the amount of the total missed
minimum distributions for prior years. In
a defined benefit plan, the permitted cor-
rection method is to distribute the
required minimum distributions, plus an
interest payment representing the loss of
use of such amounts.

.07 Failure to obtain participant
and/or spousal consent for a distribution
subject to the participant and spousal
consent rules under §§ 401(a)(11),
411(a)(11) and 417. The permitted cor-
rection method is to give each affected
participant a choice between providing
informed consent for the distribution actu-
ally made or receiving a qualified joint
and survivor annuity. In order to use this
VCS correction method, the Plan Sponsor
must have contacted each affected partic-
ipant and spouse (to whom the participant
was married at the annuity starting date)
and received responses from each such
individual before requesting consideration
under VCS. In the event that participant
and/or spousal consent is required but
cannot be obtained, the participant must
receive a qualified joint and survivor
annuity based on the monthly amount that
would have been provided under the plan
at his or her retirement date. This annuity
may be actuarially reduced to take into
account distributions already received by
the participant. However, the portion of
the qualified joint and survivor annuity
payable to the spouse upon the death of

the participant may not be actuarially
reduced to take into account prior distrib-
utions to the participant. Thus, for exam-
ple, if in accordance with the automatic
qualified joint and survivor annuity option
under a plan, a married participant who
retired would have received a qualified
joint and survivor annuity of $600 per
month payable for life with $300 per
month payable to the spouse upon the par-
ticipant's death but instead received a sin-
gle-sum distribution equal to the actuarial
present value of the participant's accrued
benefit under the plan, then the $600
monthly annuity payable during the par-
ticipant's lifetime may be actuarially
reduced to take the single-sum distribu-
tion into account. However, the spouse
must be entitled to receive an annuity of
$300 per month payable for life beginning
at the participant's death.

.08 Failure to satisfy the § 415 limits in a
defined contribution plan. The permitted
correction for failure to limit annual addi-
tions (other than elective deferrals and
employee contributions) allocated to partici-
pants in a defined contribution plan as
required in § 415 (even if the excess did not
result from the allocation of forfeitures or
from a reasonable error in estimating com-
pensation) is to place the excess annual addi-
tions into an unallocated account, similar to
the suspense account described in
§ 1.415-6(b)(6)(iii), to be used as an employ-
er contribution in the succeeding year(s).
While such amounts remain in the unallocat-
ed account, the employer is not permitted to
make additional contributions to the plan.
The permitted VCS correction for failure to
limit annual additions that are elective defer-
rals or employee contributions (even if the
excess did not result from a reasonable error
in determining the amount of elective defer-
rals or employee contributions that could be
made with respect to an individual under the
§ 415 limits) is to distribute the elective
deferrals or employee contributions using a
method similar to that described under
§ 1.415-6(b)(6)(iv). Elective deferrals and
employee contributions that are matched
may be returned, provided that the matching
contributions relating to such contributions
are forfeited (which will also reduce excess
annual additions for the affected individuals).
The forfeited matching contributions are to
be placed into an unallocated account to be
used as an employer contribution in succeed-
ing periods.

# APPENDIX B

## CORRECTION METHODS AND EXAMPLES; EARNINGS ADJUSTMENT METHODS AND EXAMPLES

## SECTION 1. PURPOSE, ASSUMPTIONS FOR EXAMPLES AND SECTION REFERENCES

.01 Purpose. (1) This appendix sets
forth correction methods relating to
Operational Failures under Qualified
Plans. This appendix also sets forth earn-
ings adjustment methods. The correction
methods and earnings adjustment meth-
ods described in this appendix are accept-
able under SCP and VCP (including VCS,
but not VCT).

(2) This appendix does not apply to
403(b) Plans or SEPs. Accordingly, spon-
sors of 403(b) Plans or SEPs cannot rely
on the correction methods and the earn-
ings adjustment methods under this
appendix.

.02 Assumptions for Examples. Unless
otherwise specified, for ease of presenta-
tion, the examples assume that:

(1) the plan year and the § 415 limi-
tation year are the calendar year;

(2) the employer maintains a single
plan intended to satisfy § 401(a) and has
never maintained any other plan;

(3) in a defined contribution plan,
the plan provides that forfeitures are used
to reduce future employer contributions;

(4) the Qualification Failures are
Operational Failures and the eligibility
and other requirements for SCP, VCP or
Audit CAP, whichever applies, are satis-
fied; and

(5) there are no Qualification
Failures other than the described
Operational Failures, and if a corrective
action would result in any additional
Qualification Failure, appropriate correc-
tive action is taken for that additional
Qualification Failure in accordance with
EPCRS.

.03 Section References. References to
section 2 and section 3 are references to
the section 2 and 3 in this appendix.

## SECTION 2. CORRECTION METHODS AND EXAMPLES

.01 ADP/ACP Failures.

(1) Correction Methods. (a) VCS
Correction Method. Appendix A, section
.03 sets forth the VCS correction method
for a failure to satisfy the actual deferral
percentage ("ADP"), actual contribution
percentage ("ACP"), or multiple use test
set forth in §§ 401(k)(3), 401(m)(2), and
401(m)(9), respectively.

(b) One-to-One Correction
Method. (i) General. In addition to the
VCS correction method, a failure to satis-
fy the ADP, ACP, or multiple use test may
be corrected using the one-to-one correc-
tion method set forth in this section
2.01(1)(b). Under the one-to-one correc-
tion method, an excess contribution
amount is determined and assigned to
highly compensated employees as provid-
ed in paragraph (1)(b)(ii) below. That
excess contribution amount (adjusted for
earnings) is either distributed to the high-
ly compensated employees or forfeited
from the highly compensated employees'
accounts as provided in paragraph
(1)(b)(iii) below. That same dollar
amount (i.e., the excess contribution
amount, adjusted for earnings) is con-
tributed to the plan and allocated to non-
highly compensated employees as provid-
ed in paragraph (1)(b)(iv) below.

(ii) Determination of the
Excess Contribution Amount. The excess
contribution amount for the year is equal
to the excess of (A) the sum of the excess
contributions (as defined in
§ 401(k)(8)(B)), the excess aggregate
contributions (as defined in
§ 401(m)(6)(B)), and the amount treated
as excess contributions or excess aggre-
gate contributions under the multiple use
test pursuant to § 401(m)(9) and
§ 1.401(m)-2(c) for the year, as assigned
to each highly compensated employee in
accordance with § 401(k)(8)(C) and
(m)(6)(C), over (B) previous corrections
that complied with § 401(k)(8), (m)(6),
and (m)(9). See Notice 97-2, 1997-1
C.B. 348.

(iii) Distributions and For-
feitures of the Excess Contribution
Amount. (A) The portion of the excess
contribution amount assigned to a particu-
lar highly compensated employee under
paragraph (1)(b)(ii) is adjusted for earn-
ings through the date of correction. The
amount assigned to a particular highly
compensated employee, as adjusted, is
distributed or, to the extent the amount

was forfeitable as of the close of the plan
year of the failure, is forfeited. If the
amount is forfeited, it is used in accor-
dance with the plan provisions relating to
forfeitures that were in effect for the year
of the failure. If the amount so assigned
to a particular highly compensated
employee has been previously distributed;
the amount is an Excess Amount within
the meaning of section 5.01(3) of this rev-
enue procedure. Thus, pursuant to section
6.05 of this revenue procedure, the
employer must notify the employee that
the Excess Amount was not eligible for
favorable tax treatment accorded to distri-
butions from qualified plans (and, specif-
ically, was not eligible for tax-free
rollover).

(B) If any matching contributions
(adjusted for earnings) are forfeited in
accordance with § 411(a)(3)(G), the for-
feited amount is used in accordance with
the plan provisions relating to forfeitures
that were in effect for the year of the fail-
ure.

(C) If a payment was made to an
employee and that payment is a forfeitable
match described in either paragraph
(1)(b)(iii)(A) or (B), then it is an
Overpayment defined in section 5.01(6) of
this revenue procedure that must be cor-
rected (see sections 2.04 and 2.05 below).

(iv) Contribution and
Allocation of Equivalent Amount. (A)
The employer makes a contribution to the
plan that is equal to the aggregate
amounts distributed and forfeited under
paragraph (1)(b)(iii)(A) (i.e., the excess
contribution amount adjusted for earn-
ings, as provided in paragraph
(1)(b)(iii)(A), which does not include any
matching contributions forfeited in accor-
dance with § 411(a)(3)(G) as provided in
paragraph (1)(b)(iii)(B)). The contribu-
tion must satisfy the vesting requirements
and distribution limitations of
§ 401(k)(2)(B) and (C).

(B)(1) This paragraph (1)(b)(iv)
(B)(1) applies to a plan that uses the cur-
rent year testing method described in
Notice 98-1, 1998-1 C.B. 327. The con-
tribution made under paragraph (1)(b)
(iv)(A) is allocated to the account bal-
ances of those individuals who were
either (I) the eligible employees for the
year of the failure who were not highly
compensated employees for that year or
(II) the eligible employees for the year of
the failure who were not highly compen-

sated employees for that year and who
also are not highly compensated employ-
ees for the year of correction.
Alternatively, the contribution is allocated
to account balances of eligible employees
described in (I) or (II) of the preceding
sentence, except that the allocation is
made only to the account balances of
those employees who are employees on a
date during the year of the correction that
is no later than the date of correction.
Regardless of which of these four options
(described in the two preceding sen-
tences) the employer selects, the contribu-
tion is allocated to each such employee
either as the same percentage of the
employee's compensation for the year of
the failure or as the same dollar amount
for each employee. (See Examples 1, 2
and 3.) Under the one-to-one correction
method, the amount allocated to the
account balance of an employee (i.e., the
employee's share of the total amount con-
tributed under paragraph (1)(b)(iv)(A)) is
not further adjusted for earnings and is
treated as an annual addition under § 415
for the year of the failure for the employ-
ee for whom it is allocated.

(2) This paragraph (1)(b)(iv)(B)(2)
applies to a plan that uses the prior year
testing method described in Notice 98-1.
Paragraph (1)(b)(iv)(B)(1) is applied by
substituting "the year prior to the year of
the failure" for "the year of the failure".

(2) Examples.

Example 1:

Employer A maintains a profit-sharing plan with
a cash or deferred arrangement that is intended to
satisfy § 401(k) ("401(k) plan") using the current
year testing method described in Notice 98-1.
The plan does not provide for matching contribu-
tions or employee after-tax contributions. In
1999, it was discovered that the ADP test for
1997 was not performed correctly. When the
ADP test was performed correctly, the test was
not satisfied for 1997. For 1997, the ADP for
highly compensated employees was 9% and the
ADP for nonhighly compensated employees was
4%. Accordingly, the ADP for highly compen-
sated employees exceeded the ADP for nonhigh-
ly compensated employees by more than two per-
centage points (in violation of § 401(k)(3)). (The
ADP for nonhighly compensated employees for
1996 also was 4%, so the ADP test for 1997
would not have been satisfied even if the plan had
used the prior year testing method described in
Notice 98-1.) There were two highly compen-
sated employees eligible under the 401(k) plan
during 1997, Employee P and Employee Q.
Employee P made elective deferrals of $8,000,
which is equal to 10% of Employee P's compen-
sation of $80,000 for 1997. Employee Q made

elective deferrals of $9,500, which is equal to 8%
of Employee Q's compensation of $118,750 for
1997.

Correction:

On June 30, 1999, Employer A uses the one-to-
one correction method to correct the failure to
satisfy the ADP test for 1997. Accordingly,
Employer A calculates the dollar amount of the
excess contributions for the two highly compen-
sated employees in the manner described in
§ 401(k)(8)(B). The amount of the excess contri-
bution for Employee P is $3,200 (4% of $80,000)
and the amount of the excess contribution for
Employee Q is $2,375 (2% of $118,750), or a
total of $5,575. In accordance with
§ 401(k)(8)(C), $5,575, the excess contribution
amount, is assigned $2,037.50 to Employee P and
$3,537.50 to Employee Q. It is determined that
the earnings on the assigned amounts through
June 30, 1999 are $407 and $707 for Employees
P and Q, respectively. The assigned amounts and
the earnings are distributed to Employees P and
Q. Therefore, Employee P receives $2,444.50
($2,037.50 + $407) and Employee Q receives
$4,244.50 ($3,537.50 + $707). In addition, on
the same date, a corrective contribution is made
to the 401(k) plan equal to $6,689 (the sum of the
$2,444.50 distributed to Employee P and the
$4,244.50 distributed to Employee Q). The cor-
rective contribution is allocated to the account
balances of eligible nonhighly compensated
employees for 1997, pro rata based on their com-
pensation for 1997 (subject to § 415 for 1997).

Example 2:

The facts are the same as in Example 1.

Correction:

The correction is the same as in Example 1,
except that the corrective contribution of $6,689
is allocated in an equal dollar amount to the
account balances of eligible nonhighly compen-
sated employees for 1997 who are employees on
June 30, 1999, and who are nonhighly compen-
sated employees for 1999 (subject to § 415 for
1997).

Example 3:

The facts are the same as in Example 1, except
that for 1997 the plan also provides (1) for
employee after-tax contributions and (2) for
matching contributions equal to 50% of the sum
of an employee's elective deferrals and employee
after-tax contributions that do not exceed 10% of
the employee's compensation. The plan provides
that matching contributions are subject to the
plan's 5-year graded vesting schedule and that
matching contributions are forfeited and used to
reduce employer contributions if associated elec-
tive deferrals or employee after-tax contributions
are distributed to correct an ADP, ACP or multi-
ple use test failure. For 1997, nonhighly com-
pensated employees made employee after-tax
contributions and no highly compensated
employee made any employee after-tax contribu-
tions. Employee P received a matching contribu-
tion of $4,000 (50% of $8,000) and Employee Q

received a matching contribution of $4,750 (50%
of $9,500). Employees P and Q were 100% vest-
ed in 1997. It is determined that, for 1997, the
ACP for highly compensated employees was not
more than 125% of the ACP for nonhighly com-
pensated employees, so that the ACP and multi-
ple use tests would have been satisfied for 1997
without any corrective action.

Correction:

The same corrective actions are taken as in
Example 1. In addition, in accordance with the
plan's terms, corrective action is taken to forfeit
Employee P's and Employee Q's matching con-
tributions associated with their distributed excess
contributions. Employee P's distributed excess
contributions and associated matching contribu-
tions are $2,037.50 and $1,018.75, respectively.
Employee Q's distributed excess contributions
and associated matching contributions are
$3,537.50 and $1,768.75, respectively. Thus,
$1,018.75 is forfeited from Employee P's account
and $1,768.75 is forfeited from Employee Q's
account. In addition, the earnings on the forfeit-
ed amounts are also forfeited. It is determined
that the respective earnings on the forfeited
amount for Employee P is $150 and for
Employee Q is $204. The total amount of the for-
feitures of $3,141.50 (Employee P's $1,018.75 +
$150 and Employee Q's $1,768.75 + $204) is
used to reduce contributions for 1999 and subse-
quent years.

### .02 Exclusion of Eligible Employees.

(1) Exclusion of Eligible Employees
in a 401(k) or (m) Plan. (a) Correction
Method. (i) VCS Correction Method for
Full Year Exclusion. Appendix A, section
.05 sets forth the VCS correction method
for the exclusion of an eligible employee
from all contributions under a 401(k) or
(m) plan for one or more full plan years.
(See Example 4.) In section 2.02(1)(a)(ii)
below, the VCS correction method for the
exclusion of an eligible employee from all
contributions under a 401(k) or (m) plan
for a full year is expanded to include cor-
rection for the exclusion of an eligible
employee from all contributions under a
401(k) or (m) plan for a partial plan year.
This correction for a partial year exclu-
sion may be used in conjunction with the
correction for a full year exclusion.

(ii) Expansion of VCS
Correction Method to Partial Year
Exclusion. (A) In General. The correc-
tion method in Appendix A, section .05 is
expanded to cover an employee who was
improperly excluded from making elec-
tive deferrals or employee after-tax con-
tributions for a portion of a plan year or
from receiving matching contributions

(on either elective deferrals or employee
after-tax contributions) for a portion of a
plan year. In such case, a permitted cor-
rection method for the failure is for the
employer to satisfy this section
2.02(1)(a)(ii). The employer makes a cor-
rective contribution on behalf of the
excluded employee that satisfies the vest-
ing requirements and distribution limita-
tions of § 401(k)(2)(B) and (C).

(B) Elective Deferral Failures. The
appropriate corrective contribution for the
failure to allow employees to make elective
deferrals for a portion of the plan year is
equal to the ADP of the employee's group
(either highly or nonhighly compensated),
determined prior to correction under this sec-
tion 2.02(1)(a)(ii), multiplied by the employ-
ee's plan compensation for the portion of the
year during which the employee was
improperly excluded. The corrective contri-
bution for the portion of the plan year during
which the employee was improperly exclud-
ed from being eligible to make elective
deferrals is reduced to the extent that (1) the
sum of that contribution and any elective
deferrals actually made by the employee for
that year would exceed (2) the maximum
elective deferrals permitted under the plan
for the employee for that plan year (includ-
ing the § 402(g) limit). The corrective con-
tribution is adjusted for earnings. (See
Examples 5 and 6.)

(C) Employee After-tax and
Matching Contribution Failures. The
appropriate corrective contribution for the
failure to allow employees to make
employee after-tax contributions or to
receive matching contributions because
the employee was precluded from making
employee after-tax contributions or elec-
tive deferrals for a portion of the plan year
is equal to the ACP of the employee's
group (either highly or nonhighly com-
pensated), determined prior to correction
under this section 2.02(1)(a)(ii), multi-
plied by the employee's plan compensa-
tion for the portion of the year during
which the employee was improperly
excluded. The corrective contribution is
reduced to the extent that (1) the sum of
that contribution and the actual total
employee after-tax and matching contri-
butions made by and for the employee for
the plan year would exceed (2) the sum of
the maximum employee after-tax contri-
butions permitted under the plan for the
employee for the plan year and the match-

ing contributions that would have been
made if the employee had made the max-
imum matchable contributions permitted
under the plan for the employee for that
plan year. The corrective contribution is
adjusted for earnings.

(D) Use of Prorated Compensation.
For purposes of this paragraph (1)(a)(ii),
for administrative convenience, in lieu of
using the employee's actual plan compen-
sation for the portion of the year during
which the employee was improperly
excluded, a pro rata portion of the
employee's plan compensation that would
have been taken into account for the plan
year, if the employee had not been
improperly excluded, may be used.

(E) Special Rule for Brief
Exclusion from Elective Deferrals. An
employer is not required to make a cor-
rective contribution with respect to elec-
tive deferrals, as provided in section
2.02(1)(a)(ii)(B), (but is required to
make a corrective contribution with
respect to any employee after-tax and
matching contributions, as provided in
section 2.02(1)(a)(ii)(C)) for an employ-
ee for a plan year if the employee has
been provided the opportunity to make
elective deferrals under the plan for a
period of at least the last 9 months in that
plan year and during that period the
employee had the opportunity to make
elective deferrals in an amount not less
than the maximum amount that would
have been permitted if no failure had
occurred. (See Example 7.)

(b) Examples.

#### Example 4:

Employer B maintains a 401(k) plan. The plan
provides for matching contributions for eligible
employees equal to 100% of elective deferrals
that do not exceed 3% of an employee's compen-
sation. The plan provides that employees who
complete one year of service are eligible to par-
ticipate in the plan on the next January 1 or July
1 entry date. Twelve employees (8 nonhighly
compensated employees and 4 highly compensat-
ed employees) who had met the one year eligibil-
ity requirement after July 1, 1995, and before
January 1, 1996, were inadvertently excluded
from participating in the plan beginning on
January 1, 1996. These employees were offered
the opportunity to begin participating in the plan
on January 1, 1997. For 1996, the ADP for the
highly compensated employees was 8% and the
ADP for the nonhighly compensated employees
was 6%. In addition, for 1996, the ACP for the
highly compensated employees was 2.5% and the
ACP for the nonhighly compensated employees

was 2%. The failure to include the 12 employees
was discovered during 1998.

#### Correction:

Employer B uses the VCS correction method for
full year exclusions to correct the failure to
include the 12 eligible employees in the plan for
the full plan year beginning January 1, 1996.
Thus, Employer B makes a corrective contribu-
tion (that satisfies the vesting requirements and
distribution limitations of § 401(k)(2)(B) and
(C)) for each of the excluded employees. The
contribution for each of the improperly excluded
highly compensated employees is 10.5% (the
highly compensated employees' ADP of 8% plus
ACP of 2.5%) of the employee's plan compensa-
tion for the 1996 plan year (adjusted for earn-
ings). The contribution for each of the improper-
ly excluded nonhighly compensated employees is
8% (the nonhighly compensated employees,'
ADP of 6% plus ACP of 2%) of the employee's
plan compensation for the 1996 plan year (adjust-
ed for earnings).

#### Example 5:

Employer C maintains a 401(k) plan. The plan
provides for matching contributions for each pay-
roll period that are equal to 100% of an employ-
ee's elective deferrals that do not exceed 2% of
the eligible employee's plan compensation during
the payroll period. The plan does not provide for
employee after-tax contributions. The plan pro-
vides that employees who complete one year of
service are eligible to participate in the plan on
the next January 1 or July 1 entry date. A non-
highly compensated employee who met the eligi-
bility requirements and should have entered the
plan on January 1, 1996, was not offered the
opportunity to participate in the plan. In August
of 1996, the error was discovered and Employer
C offered the employee an election opportunity as
of September 1, 1996. The employee made elec-
tive deferrals equal to 4% of the employee's plan
compensation for each payroll period from
September 1, 1996, through December 31, 1996,
(resulting in elective deferrals of $500). The
employee's plan compensation for 1996, was
$36,000 ($23,500 for the first eight months and
$12,500 for the last four months). Employer C
made matching contributions equal to $250 for
the excluded employee, which is 2% of the
employee's plan compensation for each payroll
period from September 1, 1996, through
December 31, 1996, ($12,500). The ADP for
nonhighly compensated employees for 1996 was
3% and the ACP for nonhighly compensated
employees for 1996 was 1.8%.

Correction:

Employer C uses the VCS correction method for
partial year exclusions to correct the failure to
include the eligible employee in the plan. Thus,
Employer C makes a corrective contribution (that
satisfies the vesting requirements and distribution
limitations of § 401(k)(2)(B) and (C)) for the
excluded employee. In determining the amount
of corrective contributions (both for the elective
deferral and for the matching contribution), for

administrative convenience, in lieu of using actu-
al plan compensation of $23,500 for the period
the employee was excluded, the employee's
annual plan compensation is pro rated for the
eight-month period that the employee was
excluded from participating in the plan. The
failure to provide the excluded employee the
right to make elective deferrals is corrected by the
employer making a corrective contribution on
behalf of the employee that is equal to $720 (the
3% ADP percentage for nonhighly compensated
employees multiplied by $24,000, which is
8/12ths of the employee's 1996 plan compensa-
tion of $36,000), adjusted for earnings. In addi-
tion, to correct for the failure to receive the plan's
matching contribution, a corrective contribution
is made on behalf of the employee that is equal to
$432 (the 1.8% ACP for the nonhighly compen-
sated group multiplied by $24,000, which is
8/12ths of the employee's 1996 plan compensa-
tion of $36,000), adjusted for earnings.
Employer C determines that $682, the sum of the
actual matching contribution received by the
employee for the plan year ($250) and the correc-
tive contribution to correct the matching contri-
bution failure ($432), does not exceed $720, the
maximum matching contribution available to the
employee under the plan (2% of $36,000) deter-
mined as if the employee had made the maximum
matchable contributions. In addition to correct-
ing the failure to include the eligible employee in
the plan, Employer C reruns the ADP and ACP
tests for 1996 (taking into account the corrective
contribution and plan compensation for 1996 for
the excluded employee) and determines that the
tests were satisfied.

Example 6:

The facts are the same as in Example 5, except
that the plan provides for matching contributions
that are equal to 100% of an eligible employee's
elective deferrals that do not exceed 2% of the
employee's plan compensation for the plan year.
Accordingly, the actual matching contribution
made by Employer C for the excluded employee
for the last four months of 1996 is $500 (which is
equal to 100% of the $500 of elective deferrals
made by the employee for the last four months of
1996).

Correction:

The correction is the same as in Example 5,
except that the corrective contribution made for
the first 8 months of 1996 to correct the failure to
make matching contributions is equal to $220
(adjusted for earnings), instead of the $432
(adjusted for earnings) in Example 5, because the
corrective contribution is limited to the maximum
matching contributions available under the plan
for the employee for the plan year, $720 (2% of
$36,000), reduced by the actual matching contri-
butions made for the employee for the plan year,
$500.

Example 7:

The facts are the same as in Example 5, except
that the error is discovered in March of 1996 and
the employee was given the opportunity to make

elective deferrals beginning on April 1, 1996.
The amount of elective deferrals that the employ-
ee was given the opportunity to make during
1996 was not less than the maximum elective
deferrals that the employee could have made if
the employee had been given the opportunity to
make elective deferrals beginning on January 1,
1996. The employee made elective deferrals
equal to 4% of the employee's plan compensation
for each payroll period from April 1, 1996
through December 31, 1996 of $28,000 (resulting
in elective deferrals of $1,120). Employer C
made a matching contribution equal to $560,
which is 2% of the employee's plan compensa-
tion for each payroll period from April 1, 1996
through December 31, 1996 ($28,000). The
employee's plan compensation for 1996 was
$36,000 ($8,000 for the first three months and
$28,000 for the last nine months).

Correction:

Employer C uses the VCS correction method for
partial year exclusions to correct the failure to
include an eligible employee in the plan.
Because the employee was given an opportunity
to make elective deferrals to the plan for at least
the last 9 months of the plan year (and the amount
of the elective deferrals that the employee had the
opportunity to make was not less than the maxi-
mum elective deferrals that the employee could
have made if the employee had been given the
opportunity to make elective deferrals beginning
on January 1, 1996), under the special rule set
forth in section 2.02(1)(a)(ii)(E), Employer C is
not required to make a corrective contribution for
the failure to allow the employee to make elective
deferrals. In determining the amount of correc-
tive contribution with respect to the failure to
allow the employee to receive matching contribu-
tions, in lieu of using actual plan compensation of
$8,000 for the period the employee was excluded,
the employee's annual plan compensation is pro
rated for the three-month period that the employ-
ee was excluded from participating in the plan.
Accordingly, a corrective contribution is made on
behalf of the employee that is equal to $160,
which is the lesser of (i) $162 (a matching contri-
bution of 1.8% of $9,000, which is 3/12ths of the
employee's 1996 plan compensation of $36,000),
and (ii) $160 (the excess of the maximum match-
ing contribution for the entire plan year, which is
equal to 2% of $36,000, or $720, over the match-
ing contributions made after March 31, 1996,
$560). The contribution is adjusted for earnings.

(2) Exclusion of Eligible Employees
In a Profit-Sharing Plan.

(a) Correction Methods. (i) VCS
Correction Method. Appendix A, section
.05 sets forth the VCS correction method
for correcting the exclusion of an eligible
employee. In the case of a defined contri-
bution plan, the VCS correction method is
to make a contribution on behalf of the
excluded employee. Section 2.02(2)(a)
(ii) below clarifies the VCS correction
method in the case of a profit-sharing or
stock bonus plan that provides for non-

elective contributions (within the meaning
of § 1.401(k)-1(g)(10)).

(ii) Clarification of VCS
Correction Method for Profit-Sharing
Plans. To correct for the exclusion of an
eligible employee from nonelective con-
tributions in a profit-sharing or stock
bonus plan under the VCS correction
method, an allocation amount is deter-
mined for each excluded employee on the
same basis as the allocation amounts were
determined for the other employees under
the plan's allocation formula (e.g., the
same ratio of allocation to compensation),
taking into account all of the employee's
relevant factors (e.g., compensation)
under that formula for that year. The
employer makes a corrective contribution
on behalf of the excluded employee that is
equal to the allocation amount for the
excluded employee. The corrective con-
tribution is adjusted for earnings. If, as a
result of excluding an employee, an
amount was improperly allocated to the
account balance of an eligible employee
who shared in the original allocation of
the nonelective contribution, no reduction
is made to the account balance of the
employee who shared in the original allo-
cation on account of the improper alloca-
tion. (See Example 8.)

(iii) Reallocation Correction
Method. (A) In General. Subject to the
limitations set forth in section
2.02(2)(a)(iii)(F) below, in addition to the
VCS correction method, the exclusion of
an eligible employee for a plan year from
a profit-sharing or stock bonus plan that
provides for nonelective contributions
may be corrected using the reallocation
correction method set forth in this section
2.02(2)(a)(iii). Under the reallocation
correction method, the account balance of
the excluded employee is increased as
provided in paragraph (2)(a)(iii)(B)
below, the account balances of other
employees are reduced as provided in
paragraph (2)(a)(iii)(C) below, and the
increases and reductions are reconciled,
as necessary, as provided in paragraph
(2)(a)(iii)(D) below. (See Examples 9 and
10.)

(B) Increase in Account Balance of
Excluded Employee. The account bal-
ance of the excluded employee is
increased by an amount that is equal to the
allocation the employee would have
received had the employee shared in the

allocation of the nonelective contribution.
The amount is adjusted for earnings.

(C) Reduction in Account Balances
of Other Employees. (1) The account bal-
ance of each employee who was an eligi-
ble employee who shared in the original
allocation of the nonelective contribution
is reduced by the excess, if any, of (I) the
employee's allocation of that contribution
over (II) the amount that would have been
allocated to that employee had the failure
not occurred. This amount is adjusted for
earnings taking into account the rules set
forth in section 2.02(2)(a)(iii)(C)(2) and
(3) below. The amount after adjustment
for earnings is limited in accordance with
section 2.02(2)(a)(iii)(C)(4) below.

(2) This paragraph (2)(a)(iii)(C)(2)
applies if most of the employees with
account balances that are being reduced
are nonhighly compensated employees. If
there has been an overall gain for the
period from the date of the original allo-
cation of the contribution through the date
of correction, no adjustment for earnings
is required to the amount determined
under section 2.02(2)(a)(iii)(C)(1) for the
employee. If the amount for the employ-
ee is being adjusted for earnings and the
plan permits investment of account bal-
ances in more than one investment fund,
for administrative convenience, the reduc-
tion to the employee's account balance
may be adjusted by the lowest earnings
rate of any fund for the period from the
date of the original allocation of the con-
tribution through the date of correction.

(3) If an employee's account balance
is reduced and the original allocation was
made to more than one investment fund or
there was a subsequent distribution or
transfer from the fund receiving the origi-
nal allocation, then reasonable, consistent
assumptions are used to determine the
earnings adjustment.

(4) The amount determined in sec-
tion 2.02(2)(a)(iii)(C)(1) for an employee
after the application of section
2.02(2)(a)(iii)(C)(2) and (3) may not
exceed the account balance of the
employee on the date of correction, and
the employee is permitted to retain any
distribution made prior to the date of cor-
rection.

(D) Reconciliation of Increases and
Reductions. If the aggregate amount of
the increases under section
2.02(2)(a)(iii)(B) exceeds the aggregate

amount of the reductions under section
2.02(2)(a)(iii)(C), the employer makes a
corrective contribution to the plan for the
amount of the excess. If the aggregate
amount of the reductions under section
2.02(2)(a)(iii)(C) exceeds the aggregate
amount of the increases under section
2.02(2)(a)(iii)(B), then the amount by
which each employee's account balance is
reduced under section 2.02(2)(a)(iii)(C) is
decreased on a pro rata basis.

(E) Reductions Among Multiple
Investment Funds. If an employee's
account balance is reduced and the employ-
ee's account balance is invested in more
than one investment fund, then the reduc-
tion may be made from the investment
funds selected in any reasonable manner.

(F) Limitations on Use of
Reallocation Correction Method. If any
employee would be permitted to retain
any distribution pursuant to section
2.02(2)(a)(iii)(C)(4), then the reallocation
correction method may not be used unless
most of the employees who would be per-
mitted to retain a distribution are non-
highly compensated employees.

(b) Examples.

#### Example 8:

Employer D maintains a profit-sharing plan that
provides for discretionary nonelective employer
contributions. The plan provides that the
employer's contributions are allocated to account
balances in the ratio that each eligible employee's
compensation for the plan year bears to the com-
pensation of all eligible employees for the plan
year and, therefore, the only relevant factor for
determining an allocation is the employee's com-
pensation. The plan provides for self-directed
investments among four investment funds and
daily valuations of account balances. For the
1997 plan year, Employer D made a contribution
to the plan of a fixed dollar amount. However,
five employees who met the eligibility require-
ments were inadvertently excluded from partici-
pating in the plan. The contribution resulted in
an allocation on behalf of each of the eligible
employees, other than the excluded employees,
equal to 10% of compensation. Most of the
employees who received allocations under the
plan for the year of the failure were nonhighly
compensated employees. No distributions have
been made from the plan since 1997. If the five
excluded employees had shared in the original
allocation, the allocation made on behalf of each
employee would have equaled 9% of compensa-
tion. The excluded employees began participat-
ing in the plan in the 1998 plan year.

Correction:

Employer D uses the VCS correction method to
correct the failure to include the five eligible

employees. Thus, Employer D makes a correc-
tive contribution to the plan. The amount of the
corrective contribution on behalf of the five
excluded employees for the 1997 plan year is
equal to 10% of compensation of each excluded
employee, the same allocation that was made for
other eligible employees, adjusted for earnings.
The excluded employees receive an allocation
equal to 10% of compensation (adjusted for earn-
ings) even though, had the excluded employees
originally shared in the allocation for the 1997
contribution, their account balances, as well as
those of the other eligible employees, would have
received an allocation equal to only 9% of com-
pensation.

#### Example 9:

The facts are the same as in Example 8.

Correction:

Employer D uses the reallocation correction
method to correct the failure to include the five eli-
gible employees. Thus, the account balances are
adjusted to reflect what would have resulted from
the correct allocation of the employer contribution
for the 1997 plan year among all eligible employ-
ees, including the five excluded employees. The
inclusion of the excluded employees in the alloca-
tion of that contribution would have resulted in
each eligible employee, including each excluded
employee, receiving an allocation equal to 9% of
compensation. Accordingly, the account balance of
each excluded employee is increased by 9% of the
employee's 1997 compensation, adjusted for earn-
ings. The account balance of each of the eligible
employees other than the excluded employees is
reduced by 1% of the employee's 1997 compensa-
tion, adjusted for earnings. Employer D determines
the adjustment for earnings using the earnings rate
of each eligible employee's excess allocation
(using reasonable, consistent assumptions).
Accordingly, for an employee who shared in the
original allocation and directed the investment of
the allocation into more than one investment fund
or who subsequently transferred a portion of a fund
that had been credited with a portion of the 1997
allocation to another fund, reasonable, consistent
assumptions are followed to determine the adjust-
ment for earnings. It is determined that the total of
the initially determined reductions in account bal-
ances exceeds the total of the required increases in
account balances. Accordingly, these initially
determined reductions are decreased pro rata so
that the total of the actual reductions in account bal-
ances equals the total of the increases in the account
balances, and Employer D does not make any cor-
rective contribution. The reductions from the
account balances are made on a pro rata basis
among all of the funds in which each employee's
account balance is invested.

##### Example 10:

The facts are the same as in Example 8.

Correction:

The correction is the same as in Example 9,
except that, because most of the employees

whose account balances are being reduced are
nonhighly compensated employees, for adminis-
trative convenience, Employer D uses the earn-
ings rate of the fund with the lowest earnings rate
for the period of the failure to adjust the reduction
to each account balance. It is determined that the
aggregate amount (adjusted for earnings) by
which the account balances of the excluded
employees is increased exceeds the aggregate
amount (adjusted for earnings) by which the
other employees' account balances are reduced.
Accordingly, Employer D makes a contribution
to the plan in an amount equal to the excess. The
reduction from account balances is made on a pro
rata basis among all of the funds in which each
employee's account balance is invested.

### .03 Vesting Failures.

(1) Correction Methods. (a)
Contribution Correction Method. A fail-
ure in a defined contribution plan to
apply the proper vesting percentage to an
employee's account balance that results
in forfeiture of too large a portion of the
employee's account balance may be cor-
rected using the contribution correction
method set forth in this paragraph. The
employer makes a corrective contribu-
tion on behalf of the employee whose
account balance was improperly forfeit-
ed in an amount equal to the improper
forfeiture. The corrective contribution is
adjusted for earnings. If, as a result of
the improper forfeiture, an amount was
improperly allocated to the account bal-
ance of another employee, no reduction
is made to the account balance of that
employee. (See Example 11.)

(b) Reallocation Correction
Method. In addition to the contribution
correction method, in a defined contribu-
tion plan under which forfeitures of
account balances are reallocated among
the account balances of the other eligible
employees in the plan, a failure to apply
the proper vesting percentage to an
employee's account balance which results
in forfeiture of too large a portion of the
employee's account balance may be cor-
rected under the reallocation correction
method set forth in this paragraph. A cor-
rective reallocation is made in accordance
with the reallocation correction method
set forth in section 2.02(2)(a)(iii), subject
to the limitations set forth in section
2.02(2)(a)(iii)(F). In applying section
2.02(2)(a)(iii)(B), the account balance of
the employee who incurred the improper
forfeiture is increased by an amount equal
to the amount of the improper forfeiture

and the amount is adjusted for earnings.
In applying section 2.02(2)(a)(iii)(C)(1),
the account balance of each employee
who shared in the allocation of the
improper forfeiture is reduced by the
amount of the improper forfeiture that
was allocated to that employee's account.
The earnings adjustments for the account
balances that are being reduced are deter-
mined in accordance with sections
2.02(2)(a)(iii)(C)(2) and (3) and the
reductions after adjustments for earnings
are limited in accordance with section
2.02(2)(a)(iii)(C)(4). In accordance with
section 2.02(2)(a)(iii)(D), if the aggregate
amount of the increases exceeds the
aggregate amount of the reductions, the
employer makes a corrective contribution
to the plan for the amount of the excess.
In accordance with section
2.02(2)(a)(iii)(D), if the aggregate amount
of the reductions exceeds the aggregate
amount of the increases, then the amount
by which each employee's account bal-
ance is reduced is decreased on a pro rata
basis. (See Example 12.)

(2) Examples.

Example 11:

Employer E maintains a profit-sharing plan that
provides for nonelective contributions. The plan
provides for self-directed investments among four
investment funds and daily valuation of account
balances. The plan provides that forfeitures of
account balances are reallocated among the
account balances of other eligible employees on the
basis of compensation. During the 1997 plan year,
Employee R terminated employment with
Employer E and elected and received a single-sum
distribution of the vested portion of his account bal-
ance. No other distributions have been made since
1997. However, an incorrect determination of
Employee R's vested percentage was made result-
ing in Employee R receiving a distribution of less
than the amount to which he was entitled under the
plan. The remaining portion of Employee R's
account balance was forfeited and reallocated (and
these reallocations were not affected by the limita-
tions of § 415). Most of the employees who
received allocations of the improper forfeiture were
nonhighly compensated employees.

Correction:

Employer E uses the contribution correction
method to correct the improper forfeiture. Thus,
Employer E makes a contribution on behalf of
Employee R equal to the incorrectly forfeited
amount (adjusted for earnings) and Employee R's
account balance is increased accordingly. No
reduction is made from the account balances of
the employees who received an allocation of the
improper forfeiture.

#### Example 12:

The facts are the same as in Example 11.

Correction:

Employer E uses the reallocation correction
method to correct the improper forfeiture. Thus,
Employee R's account balance is increased by the
amount that was improperly forfeited (adjusted
for earnings). The account of each employee
who shared in the allocation of the improper for-
feiture is reduced by the amount of the improper
forfeiture that was allocated to that employee's
account (adjusted for earnings). Because most of
the employees whose account balances are being
reduced are nonhighly compensated employees,
for administrative convenience, Employer E uses
the earnings rate of the fund with the lowest earn-
ings rate for the period of the failure to adjust the
reduction to each account balance. It is deter-
mined that the amount (adjusted for earnings) by
which the account balance of Employee R is
increased exceeds the aggregate amount (adjust-
ed for earnings) by which the other employees'
account balances are reduced. Accordingly,
Employer E makes a contribution to the plan in
an amount equal to the excess. The reduction
from the account balances is made on a pro rata
basis among all of the funds in which each
employee's account balance is invested.

.04 § 415 Failures.

(1) Failures Relating to a § 415(b)
Excess.

(a) Correction Methods. (i)
Return of Overpayment Correction
Method. Overpayments as a result of
amounts being paid in excess of the limits
of § 415(b) may be corrected using the
return of Overpayment correction method
set forth in this paragraph (1)(a)(i). The
employer takes reasonable steps to have
the Overpayment (with appropriate inter-
est) returned by the recipient to the plan
and reduces future benefit payments (if
any) due to the employee to reflect
§ 415(b). To the extent the amount
returned by the recipient is less than the
Overpayment, adjusted for earnings at the
plan's earnings rate, then the employer or
another person contributes the difference
to the plan. In addition, in accordance
with section 6.05 of this revenue proce-
dure, the employer must notify the recipi-
ent that the Overpayment was not eligible
for favorable tax treatment accorded to
distributions from qualified plans (and,
specifically, was not eligible for tax-free
rollover). (See Examples 15 and 16.)

(ii) Adjustment of Future
Payments Correction Method. (A) In
General. In addition to the return of over-
payment correction method, in the case of

plan benefits that are being distributed in
the form of periodic payments,
Overpayments as a result of amounts
being paid in excess of the limits in
§ 415(b) may be corrected by using the
adjustment of future payments correction
method set forth in this paragraph
(1)(a)(ii). Future payments to the recipi-
ent are reduced so that they do not exceed
the § 415(b) maximum limit and an addi-
tional reduction is made to recoup the
Overpayment (over a period not longer
than the remaining payment period) so that
the actuarial present value of the addition-
al reduction is equal to the Overpayment
plus interest at the interest rate used by the
plan to determine actuarial equivalence.
(See Examples 13 and 14.)

(B) Joint and Survivor Annuity
Payments. If the employee is receiving
payments in the form of a joint and sur-
vivor annuity, with the employee's spouse
to receive a life annuity upon the employ-
ee's death equal to a percentage (e.g.,
75%) of the amount being paid to the
employee, the reduction of future annuity
payments to reflect § 415(b) reduces the
amount of benefits payable during the
lives of both the employee and spouse, but
any reduction to recoup Overpayments
made to the employee does not reduce the
amount of the spouse's survivor benefit.
Thus, the spouse's benefit will be based
on the previous specified percentage (e.g.,
75%) of the maximum permitted under §
415(b), instead of the reduced annual peri-
odic amount payable to the employee.

(C) Overpayment Not Treated as an
Excess Amount. An Overpayment cor-
rected under this adjustment of future
payment correction method is not treated
as an Excess Amount as defined in section
5.01(3) of this revenue procedure.

(b) Examples.

Example 13:

Employer F maintains a defined benefit plan
funded solely through employer contributions.
The plan provides that the benefits of employees
are limited to the maximum amount permitted
under § 415(b), disregarding cost-of-living
adjustments under § 415(d) after benefit pay-
ments have commenced. At the beginning of the
1998 plan year, Employee S retired and started
receiving an annual straight life annuity of
$140,000 from the plan. Due to an administrative
error, the annual amount received by Employee S
for 1998 included an Overpayment of $10,000
(because the § 415(b)(1)(A) limit for 1998 was
$130,000). This error was discovered at the
beginning of 1999.

Correction:

Employer F uses the adjustment of future payments
correction method to correct the failure to satisfy the
limit in § 415(b). Future annuity benefit payments to
Employee S are reduced so that they do not exceed
the § 415(b) maximum limit, and, in addition,
Employee S's future benefit payments from the plan
are actuarially reduced to recoup the Overpayment.
Accordingly, Employee S's future benefit payments
from the plan are reduced to $130,000 and further
reduced by $1,000 annually for life, beginning in
1999. The annual benefit amount is reduced by
$1,000 annually for life because, for Employee S,
the actuarial present value of a benefit of $1,000
annually for life commencing in 1999 is equal to the
sum of $10,000 and interest at the rate used by the
plan to determine actuarial equivalence beginning
with the date of the first Overpayment and ending
with the date the reduced annuity payment begins.
Thus, Employee S's remaining benefit payments are
reduced so that Employee S receives $129,000 for
1999, and for each year thereafter.

Example 14:

The facts are the same as in Example 13.

Correction:

Employer F uses the adjustments of future pay-
ments correction method to correct the § 415(b)
failure, by recouping the entire excess payment
made in 1998 from Employee S's remaining ben-
efit payments for 1999. Thus, Employee S's
annual annuity benefit for 1999 is reduced to
$119,400 to reflect the excess benefit amounts
(increased by interest) that were paid from the
plan to Employee S during the 1998 plan year.
Beginning in 2000, Employee S begins to receive
annual benefit payments of $130,000.

Example 15:

The facts are the same as in Example 13, except
that the benefit was paid to Employee S in the form
of a single-sum distribution in 1998, which exceed-
ed the maximum § 415(b) limits by $110,000.

Correction:

Employer F uses the return of overpayment cor-
rection method to correct the § 415(b) failure.
Thus, Employer F notifies Employee S of the
$110,000 Overpayment and that the
Overpayment was not eligible for favorable tax
treatment accorded to distributions from qualified
plans (and, specifically, was not eligible for tax-
free rollover). The notice also informs Employee
S that the Overpayment (with interest at the rate
used by the plan to calculate the single-sum pay-
ment) is owed to the plan. Employer F takes rea-
sonable steps to have the Overpayment (with
interest at the rate used by the plan to calculate
the single-sum payment) paid to the plan.
Employee S pays the $110,000 (plus the request-
ed interest) to the plan. It is determined that the
plan's earnings rate for the relevant period was 2
percentage points more than the rate used by the
plan to calculate the single-sum payment.
Accordingly, Employer F contributes the differ-
ence to the plan.

2001-7 I.R.B.

Example 16:

The facts are the same as in Example 15.

Correction:

Employer F uses the return of overpayment cor-
rection method to correct the § 415(b) failure.
Thus, Employer F notifies Employee S of the
$110,000 Overpayment and that the
Overpayment was not eligible for favorable tax
treatment accorded to distributions from qualified
plans (and, specifically, was not eligible for tax-
free rollover). The notice also informs Employee
S that the Overpayment (with interest at the rate
used by the plan to calculate the single-sum pay-
ment) is owed to the plan. Employer F takes rea-
sonable steps to have the Overpayment (with
interest at the rate used by the plan to calculate
the single-sum payment) paid to the plan. As a
result of Employer F's recovery efforts, some, but
not all, of the Overpayment (with interest) is
recovered from Employee S. It is determined that
the amount returned by Employee S to the plan is
less than the Overpayment adjusted for earnings
at the plan's earnings rate. Accordingly,
Employer F contributes the difference to the plan.

(2) Failures Relating to a § 415(c)
Excess.

(a) Correction Methods. (i) VCS
Correction Method. Appendix A, section
.08 sets forth the VCS correction method
for correcting the failure to satisfy the
§ 415(c) limits on annual additions.

(ii) Forfeiture Correction
Method. In addition to the VCS correction
method, the failure to satisfy § 415(c) with
respect to a nonhighly compensated
employee (A) who in the limitation year of
the failure had annual additions consisting
of both (I) either elective deferrals or
employee after-tax contributions or both
and (II) either matching or nonelective con-
tributions or both, (B) for whom the match-
ing and nonelective contributions equal or
exceed the portion of the employee's annu-
al addition that exceeds the limits under §
415(c) ("§ 415(c) excess") for the limitation
year, and (C) who has terminated with no
vested interest in the matching and nonelec-
tive contributions (and has not been reem-
ployed at the time of the correction), may

be corrected by using the forfeiture correc-
tion method set forth in this paragraph. The
§ 415(c) excess is deemed to consist solely
of the matching and nonelective contribu-
tions. If the employee's § 415(c) excess
(adjusted for earnings) has previously been
forfeited, the § 415(c) failure is deemed to
be corrected. If the § 415(c) excess (adjust-
ed for earnings) has not been forfeited, that
amount is placed in an unallocated account,
similar to the suspense account described in
§ 1.415-6(b)(6)(iii), to be used to reduce
employer contributions in succeeding
year(s) (or if the amount would have been
allocated to other employees who were in
the plan for the year of the failure if the fail-
ure had not occurred, then that amount is
reallocated to the other employees in accor-
dance with the plan's allocation formula).
Note that while this correction method will
permit more favorable tax treatment of
elective deferrals for the employee than the
VCS correction method, this correction
method could be less favorable to the
employee in certain cases, for example, if
the employee is subsequently reemployed
and becomes vested. (See Examples 17 and
18.)

(iii) Return of Overpayment
Correction Method. A failure to satisfy
§ 415(c) that includes a distribution of the
§ 415(c) excess attributable to nonelective
contributions and matching contributions
may be corrected using the return of over-
payment correction method set forth in
this paragraph. The employer takes rea-
sonable steps to have the Overpayment
(i.e., the distribution of the § 415(c)
excess adjusted for earnings to the date of
the distribution), plus appropriate interest
from the date of the distribution to the
date of the repayment, returned by the
employee to the plan. To the extent the
amount returned by the employee is less
than the Overpayment adjusted for earn-
ings at the plan's earnings rate, then the
employer or another person contributes

the difference to the plan. The
Overpayment, adjusted for earnings at the
plan's earnings rate to the date of the
repayment, is to be placed in an unallocat-
ed account, similar to the suspense
account described in § 1.415-6(b)(6)(iii),
to be used to reduce employer contribu-
tions in succeeding year(s) (or if the
amount would have been allocated to
other eligible employees who were in the
plan for the year of the failure if the fail-
ure had not occurred, then that amount is
reallocated to the other eligible employees
in accordance with the plan's allocation
formula). In addition, the employer must
notify the employee that the Overpayment
was not eligible for favorable tax treat-
ment accorded to distributions from qual-
ified plans (and, specifically, was not eli-
gible for tax-free rollover).

(b) Examples.

Example 17:

Employer G maintains a 401(k) plan. The plan
provides for nonelective employer contributions,
elective deferrals, and employee after-tax contri-
butions. The plan provides that the nonelective
contributions vest under a 5-year cliff vesting
schedule. The plan provides that when an
employee terminates employment, the employ-
ee's nonvested account balance is forfeited five
years after a distribution of the employee's vest-
ed account balance and that forfeitures are used
to reduce employer contributions. For the 1998
limitation year, the annual additions made on
behalf of two nonhighly compensated employ-
ees in the plan, Employees T and U, exceeded
the limit in § 415(c). For the 1998 limitation
year, Employee T had § 415 compensation of
$60,000, and, accordingly, a § 415(c)(1)(B) limit
of $15,000. Employee T made elective deferrals
and employee after-tax contributions. For the
1998 limitation year, Employee U had § 415
compensation of $40,000, and, accordingly, a
§ 415(c)(1)(B) limit of $10,000. Employee U
made elective deferrals. Also, on January 1,
1999, Employee U, who had three years of ser-
vice with Employer G, terminated his employ-
ment and received his entire vested account bal-
ance (which consisted of his elective deferrals).
The annual additions for Employees T and U
consisted of:

Nonelective

$7,500

$4,500

Contributions

Elective Deferrals

10,000

5,800

After-tax

500

Contributions

Total Contributions

$18,000

$10,300

§ 415(c) Limit

$15,000

$10,000

§ 415(c) Excess

$3,000

$300

Correction:

Employer G uses the VCS correction method to
correct the § 415(c) excess with respect to
Employee T (i.e., $3,000). Thus, a distribution of
plan assets (and corresponding reduction of the
account balance) consisting of $500 (adjusted for
earnings) of employee after-tax contributions and
$2,500 (adjusted for earnings) of elective defer-
rals is made to Employee T. Employer G uses the
forfeiture correction method to correct the
§ 415(c) excess with respect to Employee U.
Thus, the § 415(c) excess is deemed to consist
solely of the nonelective contributions.
Accordingly, Employee U's nonvested account
balance is reduced by $300 (adjusted for earn-
ings) which is placed in an unallocated account,
similar to the suspense account described in
§ 1.415-6(b)(6)(iii), to be used to reduce employ-
er contributions in succeeding year(s). After cor-
rection, it is determined that the ADP and ACP
tests for 1998 were satisfied.

Example 18:

Employer H maintains a 401(k) plan. The plan
provides for nonelective employer contributions,
matching contributions and elective deferrals.
The plan provides for matching contributions that
are equal to 100% of an employee's elective
deferrals that do not exceed 8% of the employee's
plan compensation for the plan year. For the
1998 limitation year, Employee V had § 415
compensation of $50,000, and, accordingly, a
§ 415(c)(1)(B) limit of $12,500. During that lim-
itation year, the annual additions for Employee V
totaled $15,000, consisting of $5,000 in elective
deferrals, a $4,000 matching contribution (8% of
$50,000), and a $6,000 nonelective employer
contribution. Thus, the annual additions for
Employee V exceeded the § 415(c) limit by
$2,500.

Correction:

Employer H uses the VCS correction method to
correct the § 415(c) excess with respect to
Employee V (i.e., $2,500). Accordingly, $1,000
of the unmatched elective deferrals (adjusted for
earnings) are distributed to Employee V. The
remaining $1,500 excess is apportioned equally
between the elective deferrals and the associated
matching employer contributions, so Employee
V's account balance is further reduced by distrib-
uting to Employee V $750 (adjusted for earnings)
of the elective deferrals and forfeiting $750
(adjusted for earnings) of the associated employ-
er matching contributions. The forfeited match-
ing contributions are placed in an unallocated
account; similar to the suspense account
described in § 1.415-6(b)(6)(iii), to be used to
reduce employer contributions in succeeding
year(s). After correction, it is determined that the
ADP and ACP tests for 1998 were satisfied.

### .05 Correction of Other Overpayment Failures.

An Overpayment, other than one
described in section 2.04(1) (relating to a

§ 415(b) excess) or section 2.04(2) (relat-
ing to a § 415(c) excess), may be correct-
ed in accordance with this section 2.05.
An Overpayment from a defined benefit
plan is corrected in accordance with the
rules in section 2.04(1). An Overpayment
from a defined contribution plan is cor-
rected in accordance with the rules in sec-
tion 2.04(2)(a)(iii).

### .06 § 401(a)(17) Failures.

(1) Reduction of Account Balance
Correction Method. The allocation of
contributions or forfeitures under a
defined contribution plan for a plan year
on the basis of compensation in excess of
the limit under § 401(a)(17) for the plan
year may be corrected using the reduction
of account balance correction method set
forth in this paragraph. The account bal-
ance of an employee who received an
allocation on the basis of compensation in
excess of the § 401(a)(17) limit is reduced
by this improperly allocated amount
(adjusted for earnings). If the improperly
allocated amount would have been allo-
cated to other employees in the year of the
failure if the failure had not occurred, then
that amount (adjusted for earnings) is
reallocated to those employees in accor-
dance with the plan's allocation formula.
If the improperly allocated amount would
not have been allocated to other employ-
ees absent the failure, that amount (adjust-
ed for earnings) is placed in an unallocat-
ed account, similar to the suspense
account described in § 1.415-6(b)(6)(iii),
to be used to reduce employer contribu-
tions in succeeding year(s). For example,
if a plan provides for a fixed level of
employer contributions for each eligible
employee, and the plan provides that for-
feitures are used to reduce future employ-
er contributions, the improperly allocated
amount (adjusted for earnings) would be
used to reduce future employer contribu-
tions. (See Example 19.) If a payment
was made to an employee and that pay-
ment was attributable to an improperly
allocated amount, then it is an
Overpayment defined in section 5.01(6)
of this revenue procedure that must be
corrected (see sections 2.04 and 2.05).

(2) Example.

Example 19:

Employer J maintains a money purchase pen-
sion plan. Under the plan, an eligible employee

is entitled to an employer contribution of 8% of
the employee's compensation up to the
§ 401(a)(17) limit ($160,000 for 1998). During
the 1998 plan year, an eligible employee,
Employee W, inadvertently was credited with a
contribution based on compensation above the
§ 401(a)(17) limit. Employee W's compensa-
tion for 1998 was $220,000. Employee W
received a contribution of $17,600 for 1998
(8% of $220,000), rather than the contribution
of $12,800 (8% of $160,000) provided by the
plan for that year, resulting in an improper allo-
cation of $4,800.

Correction:

The § 401(a)(17) failure is corrected using the
reduction of account balance method by reduc-
ing Employee W's account balance by $4,800
(adjusted for earnings) and crediting that amount
to an unallocated account, similar to the sus-
pense account described in § 1.415-6(b)(6)(iii),
to be used to reduce employer contributions in
succeeding year(s).

#### .07 Correction by Amendment Under VCP and SCP.

(1) § 401(a)(17) Failures. (a)
Contribution Correction Method. In
addition to the reduction of account bal-
ance correction method under section
2.06 of this Appendix B, an employer
may correct a § 401(a)(17) failure for a
plan year under a defined contribution
plan under VCP and SCP (in accordance
with the requirements of sections 8, 10,
and 11) by using the contribution correc-
tion method set forth in this paragraph.
The employer contributes an additional
amount on behalf of each of the other
employees (excluding each employee
for whom there was a § 401(a)(17) fail-
ure) who received an allocation for the
year of the failure, amending the plan (as
necessary) to provide for the additional
allocation. The amount contributed for
an employee is equal to the employee's
plan compensation for the year of the
failure multiplied by a fraction, the
numerator of which is the improperly
allocated amount made on behalf of the
employee with the largest improperly
allocated amount, and the denominator
of which is the limit under § 401(a)(17)
applicable to the year of the failure. The
resulting additional amount for each of
the other employees is adjusted for earn-
ings. (See Example 20.)

(b) Examples.

Example 20:

The facts are the same as in Example 19.

Correction:

Employer J corrects the failure under VCP using
the contribution correction method by (1)
amending the plan to increase the contribution
percentage for all eligible employees (other than
Employee W) for the 1998 plan year and (2)
contributing an additional amount (adjusted for
earnings) for those employees for that plan year.
To determine the increase in the plan's contribu-
tion percentage (and the additional amount con-
tributed on behalf of each eligible employee),
the improperly allocated amount ($4,800) is
divided by the § 401(a)(17) limit for 1998
($160,000). Accordingly, the plan is amended to
increase the contribution percentage by 3 per-
centage points ($4,800/$160,000) from 8% to
11%. In addition, each eligible employee for the
1998 plan year (other than Employee W)
receives an additional contribution of 3% multi-
plied by that employee's plan compensation for
1998. This additional contribution is adjusted
for earnings.

(2) Hardship Distribution Failures.
(a) Plan Amendment Correction Method.
The Operational Failure of making hard-
ship distributions to employees under a
plan that does not provide for hardship
distributions may be corrected under VCP
and SCP using the plan amendment cor-
rection method set forth in this paragraph.
The plan is amended retroactively to pro-
vide for the hardship distributions that
were made available. This paragraph
does not apply unless (i) the amendment
satisfies § 401(a), and (ii) the plan as
amended would have satisfied the qualifi-
cation requirements of § 401(a) (including
the requirements applicable to hardship
distributions under § 401(k), if applica-
ble) had the amendment been adopted
when hardship distributions were first
made available. (See Example 21.)

(b) Example.

Example 21:

Employer K, a for-profit corporation, maintains a
401(k) plan. Although plan provisions in 1998
did not provide for hardship distributions, begin-
ning in 1998 hardship distributions of amounts
allowed to be distributed under § 401(k) were
made currently and effectively available to all
employees (within the meaning of
§ 1.401(a)(4)-4). The standard used to determine
hardship satisfied the deemed hardship distribu-
tion standards in § 1.401(k)-1(d)(2). Hardship
distributions were made to a number of employ-
ees during the 1998 and 1999 plan years, creating
an Operational Failure. The failure was discov-
ered in 2000.

Correction:

Employer K corrects the failure under VCP by
adopting a plan amendment, effective January 1,

1998, to provide a hardship distribution option
that satisfies the rules applicable to hardship dis-
tributions in § 1.401(k)-1(d)(2). The amendment
provides that the hardship distribution option is
available to all employees. Thus, the amendment
satisfies § 401(a), and the plan as amended in
2000 would have satisfied § 401(a) (including
§ 1.401(a)(4)-4 and the requirements applicable
to hardship distributions under § 401(k)) if the
amendment had been adopted in 1998.

(3) Inclusion of Ineligible Employee
Failure. (a) Plan Amendment Correction
Method. The Operational Failure of
including an ineligible employee in the
plan who has not completed the plan's
minimum age or service requirements
may be corrected under VCP and SCP by
using the plan amendment correction
method set forth in this paragraph. The
plan is amended retroactively to change
the eligibility provisions to provide for the
inclusion of the ineligible employee to
reflect the plan's actual operations. This
paragraph does not apply unless (i) the
amendment satisfies § 401(a) at the time it
is adopted, (ii) the amendment would
have satisfied § 401(a) had the amend-
ment been adopted at the earlier time
when it is effective, and (iii) the employ-
ees affected by the amendment are pre-
dominantly nonhighly compensated
employees.

(b) Example.

Example 22:

Employer L maintains a 401(k) plan applicable to
all of its employees who have at least six months
of service. The plan is a calendar year plan. The
plan provides that Employer L will make match-
ing contributions based upon an employee's
salary reduction contributions. In 2001, it is dis-
covered that all four employees who were hired
by Employer L in 2000 were permitted to make
salary reduction contributions to the plan effec-
tive with the first weekly paycheck after they
were employed. Three of the four employees are
nonhighly compensated. Employer L matched
these employees' salary reduction contributions
in accordance with the plan's matching contribu-
tion formula. Employer L calculates the ADP and
ACP tests for 2000 (taking into account the salary
reduction and matching contributions that were
made for these employees) and determines that
the tests were satisfied.

Correction:

Employer L corrects the failure under SCP by
adopting a plan amendment, effective for
employees hired on or after January 1, 2000, to
provide that there is no service eligibility
requirement under the plan and submitting the
amendment to the Service for a determination
letter.

## SECTION 3. EARNINGS ADJUSTMENT METHODS AND EXAMPLES

.01 Earnings Adjustment Methods. (1)
In general. (a) Under section 6.02(4)(a) of
this revenue procedure, whenever the
appropriate correction method for an
Operational Failure in a defined contribu-
tion plan includes a corrective contribu-
tion or allocation that increases one or
more employees' account balances (now
or in the future), the contribution or allo-
cation is adjusted for earnings and forfei-
tures. This section 3 provides earnings
adjustment methods (but not forfeiture
adjustment methods) that may be used by
an employer to adjust a corrective contri-
bution or allocation for earnings in a
defined contribution plan. Consequently,
these earnings adjustment methods may
be used to determine the earnings adjust-
ments for corrective contributions or allo-
cations made under the correction meth-
ods in section 2 and under the VCS
correction methods in Appendix A. If an
earnings adjustment method in this sec-
tion 3 is used to adjust a corrective contri-
bution or allocation, that adjustment is
treated as satisfying the earnings adjust-
ment requirement of section 6.02(4)(a) of
this revenue procedure. Other earnings
adjustment methods, different from those
illustrated in this section 3, may also be
appropriate for adjusting corrective con-
tributions or allocations to reflect earn-
ings.

(b) Under the earnings adjustment
methods of this section 3, a corrective con-
tribution or allocation that increases an
employee's account balance is adjusted to
reflect an "earnings amount" that is based on
the earnings rate(s) (determined under sec-
tion 3.01(3)) for the period of the failure
(determined under section 3.01(2)). The
earnings amount is allocated in accordance
with section 3.01(4).

(c) The rule in section 6.02(5)(a) of
this revenue procedure permitting reason-
able estimates in certain circumstances
applies for purposes of this section 3. For
this purpose, a determination of earnings
made in accordance with the rules of admin-
istrative convenience set forth in this section
3 is treated as a precise determination of
earnings. Thus, if the probable difference
between an approximate determination of
earnings and a determination of earnings

under this section 3 is insignificant and the
administrative cost of a precise determina-
tion would significantly exceed the probable
difference, reasonable estimates may be used
in calculating the appropriate earnings.

(d) This section 3 does not apply
to corrective distributions or corrective
reductions in account balances. Thus, for
example, while this section 3 applies in
increasing the account balance of an
improperly excluded employee to correct
the exclusion of the employee under the
reallocation correction method described
in section 2.02(2)(a)(iii)(B), this section 3
does not apply in reducing the account
balances of other employees under the
reallocation correction method. (See sec-
tion 2.02(2)(a)(iii)(C) for rules that apply
to the earnings adjustments for such
reductions.) In addition, this section 3
does not apply in determining earnings
adjustments under the one-to-one correc-
tion method described in section
2.01(1)(b)(iii).

(2) Period of the Failure. (a) General
Rule. For purposes of this section 3, the
"period of the failure" is the period from
the date that the failure began through the
date of correction. For example, in the
case of an improper forfeiture of an
employee's account balance, the begin-
ning of the period of the failure is the date
as of which the account balance was
improperly reduced.

(b) Rules for Beginning Date for
Exclusion of Eligible Employees from
Plan. (i) General Rule. In the case of an
exclusion of an eligible employee from a
plan contribution, the beginning of the
period of the failure is the date on which
contributions of the same type (e.g., elec-
tive deferrals, matching contributions, or
discretionary nonelective employer con-
tributions) were made for other employ-
ees for the year of the failure. In the case
of an exclusion of an eligible employee
from an allocation of a forfeiture, the
beginning of the period of the failure is
the date on which forfeitures were allocat-
ed to other employees for the year of the
failure.

(ii) Exclusion from a 401(k) or
(m) Plan. For administrative conve-
nience, for purposes of calculating the
earnings rate for corrective contributions
for a plan year (or the portion of the plan
year) during which an employee was
improperly excluded from making period-

ic elective deferrals or employee after-tax
contributions, or from receiving periodic
matching contributions, the employer
may treat the date on which the contribu-
tions would have been made as the mid-
point of the plan year (or the midpoint of
the portion of the plan year) for which the
failure occurred. Alternatively, in this
case, the employer may treat the date on
which the contributions would have been
made as the first date of the plan year (or
the portion of the plan year) during which
an employee was excluded, provided that
the earnings rate used is one half of the
earnings rate applicable under section
3.01(3) for the plan year (or the portion of
the plan year) for which the failure
occurred.

(3) Earnings Rate. (a) General Rule.
For purposes of this section 3, the earn-
ings rate generally is based on the invest-
ment results that would have applied to
the corrective contribution or allocation if
the failure had not occurred.

(b) Multiple Investment Funds. If
a plan permits employees to direct the
investment of account balances into more
than one investment fund, the earnings
rate is based on the rate applicable to the
employee's investment choices for the
period of the failure. For administrative
convenience, if most of the employees for
whom the corrective contribution or allo-
cation is made are nonhighly compensat-
ed employees, the rate of return of the
fund with the highest earnings rate under
the plan for the period of the failure may
be used to determine the earnings rate for
all corrective contributions or allocations.
If the employee had not made any applic-
able investment choices, the earnings rate
may be based on the earnings rate under
the plan as a whole (i.e., the average of the
rates earned by all of the funds in the val-
uation periods during the period of the
failure weighted by the portion of the plan
assets invested in the various funds during
the period of the failure).

(c) Other Simplifying Assumptions.
For administrative convenience, the earnings
rate applicable to the corrective contribution
or allocation for a valuation period with
respect to any investment fund may be
assumed to be the actual earnings rate for the
plan's investments in that fund during that
valuation period. For example, the earnings
rate may be determined without regard to
any special investment provisions that vary

according to the size of the fund. Further, the
earnings rate applicable to the corrective
contribution or allocation for a portion of a
valuation period may be a pro rata portion of
the earnings rate for the entire valuation peri-
od, unless the application of this rule would
result in either a significant understatement
or overstatement of the actual earnings dur-
ing that portion of the valuation period.

(4) Allocation Methods. (a) In
General. For purposes of this section 3,
the earnings amount generally may be
allocated in accordance with any of the
methods set forth in this paragraph (4).
The methods under paragraph (4)(c), (d),
and (e) are intended to be particularly
helpful where corrective contributions are
made at dates between the plan's valua-
tion dates.

(b) Plan Allocation Method.
Under the plan allocation method, the
earnings amount is allocated to account
balances under the plan in accordance
with the plan's method for allocating
earnings as if the failure had not occurred.
(See Example 23.)

(c) Specific Employee Allocation
Method. Under the specific employee
allocation method, the entire earnings
amount is allocated solely to the account
balance of the employee on whose behalf
the corrective contribution or allocation is
made (regardless of whether the plan's
allocation method would have allocated
the earnings solely to that employee). In
determining the allocation of plan earn-
ings for the valuation period during which
the corrective contribution or allocation is
made, the corrective contribution or allo-
cation (including the earnings amount) is
treated in the same manner as any other
contribution under the plan on behalf of
the employee during that valuation peri-
od. Alternatively, where the plan's alloca-
tion method does not allocate plan earn-
ings for a valuation period to a
contribution made during that valuation
period, plan earnings for the valuation
period during which the corrective contri-
bution or allocation is made may be allo-
cated as if that employee's account bal-
ance had been increased as of the last day
of the prior valuation period by the cor-
rective contribution or allocation, includ-
ing only that portion of the earnings
amount attributable to earnings through
the last day of the prior valuation period.
The employee's account balance is then

further increased as of the last day of the
valuation period during which the correc-
tive contribution or allocation is made by
that portion of the earnings amount attrib-
utable to earnings after the last day of the
prior valuation period. (See Example
24.)

(d) Bifurcated Allocation Method.
Under the bifurcated allocation method,
the entire earnings amount for the valua-
tion periods ending before the date the
corrective contribution or allocation is
made is allocated solely to the account
balance of the employee on whose behalf
the corrective contribution or allocation is
made. The earnings amount for the valu-
ation period during which the corrective
contribution or allocation is made is allo-
cated in accordance with the plan's
method for allocating other earnings for
that valuation period in accordance with
section 3.01(4)(b). (See Example 25.)

(e) Current Period Allocation
Method. Under the current period alloca-
tion method, the portion of the earnings
amount attributable to the valuation peri-
od during which the period of the failure
begins ("first partial valuation period") is
allocated in the same manner as earnings
for the valuation period during which the

corrective contribution or allocation is
made in accordance section 3.01(4)(b).
The earnings for the subsequent full valu-
ation periods ending before the beginning
of the valuation period during which the
corrective contribution or allocation is
made are allocated solely to the employee
for whom the required contribution
should have been made. The earnings
amount for the valuation period during
which the corrective contribution or allo-
cation is made ("second partial valuation
period") is allocated in accordance with
the plan's method for allocating other
earnings for that valuation period in
accordance with section 3.01(4)(b). (See
Example 26.)

.02 Examples.

Example 23:

Employer L maintains a profit-sharing plan that
provides only for nonelective contributions. The
plan has a single investment fund. Under the
plan, assets are valued annually (the last day of
the plan year) and earnings for the year are allo-
cated in proportion to account balances as of the
last day of the prior year, after reduction for dis-
tributions during the current year but without
regard to contributions received during the cur-
rent year (the "prior year account balance"). Plan
contributions for 1997 were made on March 31,
1998. On April 20, 2000, Employer L determines

Time Periods

3/31/98 - 12/31/98 (First Partial Valuation Period)

1/1/99 - 12/31/99

1/1/00 - 6/1/00 (Second Partial Valuation Period)

If the $5,000 corrective contribution had been con-
tributed for Employee X on March 31, 1998, (1)
earnings for 1998 would have been increased by
the amount of the earnings on the additional $5,000
contribution from March 31, 1998, through
December 31, 1998, and would have been allocat-
ed as 1998 earnings in proportion to the prior year
(December 31, 1997) account balances, (2)
Employee X's account balance as of December 31,
1998, would have been increased by the additional
$5,000 contribution, (3) earnings for 1999 would
have been increased by the 1999 earnings on the
additional $5,000 contribution (including 1998
earnings thereon) allocated in proportion to the
prior year (December 31, 1998) account balances
along with other 1999 earnings, and (4) earnings
for 2000 would have been increased by the earn-
ings on the additional $5,000 (including 1998 and
1999 earnings thereon) from January 1 to June 1,
2000, and would be allocated in proportion to the

prior year (December 31, 1999) account balances
along with other 2000 earnings. Accordingly, the
$5,000 corrective contribution is adjusted to reflect
an earnings amount of $2,084
($5,000[(1.15)(1.10)(1.12)-1]) and the earnings
amount is allocated to the account balances under
the plan allocation method as follows:

(a) Each account balance that shared in the allo-
cation of earnings for 1998 is increased, as of
December 31, 1998, by its appropriate share of
the earnings amount for 1998, $750
($5,000(.15)).

(b) Employee X's account balance is increased,
as of December 31, 1998, by $5,000.

(c) The resulting December 31, 1998 account bal-
ances will share in the 1999 earnings, including
the $575 for 1999 earnings included in the cor-
rective contribution ($5,750(.10)), to determine
the account balances as of December 31, 1999.
However, each account balance other than

that an operational failure occurred for 1997
because Employee X was improperly excluded
from the plan. Employer L decides to correct the
failure by using the VCS correction method for
the exclusion of an eligible employee from non-
elective contributions in a profit-sharing plan.
Under this method, Employer L determines that
this failure is corrected by making a contribution
on behalf of Employee X of $5,000 (adjusted for
earnings). The earnings rate under the plan for
1998 was +20%. The earnings rate under the
plan for 1999 was +10%. On May 15, 2000,
when Employer L determines that a contribution
to correct for the failure will be made on June 1,
2000, a reasonable estimate of the earnings rate
under the plan from January 1, 2000 to June 1,
2000 is +12%.

Earnings Adjustment on the Corrective
Contribution:

The $5,000 corrective contribution on behalf of
Employee X is adjusted to reflect an earnings
amount based on the earnings rates for the period
of the failure (March 31, 1998 through June 1,
2000) and the earnings amount is allocated using
the plan allocation method. Employer L deter-
mines that a pro rata simplifying assumption may
be used to determine the earnings rate for the
period from March 31, 1998, to December 31,
1998, because that rate does not significantly
understate or overstate the actual earnings for that
period. Accordingly, Employer L determines that
the earnings rate for that period is 15% (9/12 of
the plan's 20% earnings rate for the year). Thus,
applicable earnings rates under the plan during
the period of the failure are:

Earnings Rate

+15%

+10%

+12%

Employee X's account balance has already
shared in the 1999 earnings, excluding the $575.
Accordingly, Employee X's account balance as of
December 31, 1999 will include $500 of the
1999 portion of the earnings amount based on the
$5,000 corrective contribution allocated to
Employee X's account balance as of December
31, 1998 ($5,000(.10)). Then each account bal-
ance that originally shared in the allocation of
earnings for 1999 (i.e., excluding the $5,500
additions to Employee X's account balance) is
increased by its appropriate share of the remain-
ing 1999 portion of the earnings amount, $75.

(d) The resulting December 31, 1999, account
balances (including the $5,500 additions to
Employee X's account balance) will share in the
2000 portion of the earnings amount based on the
estimated January 1, 2000, to June 1, 2000, earn-
ings included in the corrective contribution equal
to $759 ($6,325(.12)). (See Table 1.)

TABLE 1 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate

Amount

Allocated to:

Corrective Contribution

$5,000

Employee X

First Partial Valuation Period Earnings

15%

7501

All 12/31/1997 Account Balances4

1999 Earnings

10%

5752

Employee X ($500)/ All 12/31/1998 Account Balances ($75)4

Second Partial Valuation Period Earnings

12%

7593

All 12/31/1999 Account Balances (including Employee X's $5,500)4

Total Amount Contributed

$7,084

1$5,000 x 15%

2$5,750($5,000 +750) x 10%

3$6,325($5,000 +750 +575) x 12%

4 After reduction for distributions during the year for which earning are being determined but without regard to contributions received during the year for which
earnings are being determined.

### Example 24:

The facts are the same as in Example 23.

Earnings Adjustment on the Corrective
Contribution:

The earnings amount on the corrective contribu-
tion is the same as in Example 23, but the earn-
ings amount is allocated using the specific
employee allocation method. Thus, the entire

earnings amount for all periods through June 1,
2000 (i.e., $750 for March 31, 1998 to December
31, 1998, $575 for 1999, and $759 for January 1,
2000 to June 1, 2000) is allocated to Employee X.
Accordingly, Employer L makes a contribution
on June 1, 2000, to the plan of $7,084
($5,000(1.15)(1.10)(1.12)). Employee X's
account balance as of December 31, 2000, is

increased by $7,084. Alternatively, Employee
X's account balance as of December 31, 1999, is
increased by $6,325 ($5,000(1.15)(1.10)), which
shares in the allocation of earnings for 2000, and
Employee X's account balance as of December
31, 2000 is increased by the remaining $759.
(See Table 2.)

TABLE 2 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate

Amount

Allocated to:

Corrective Contribution

$5,000

Employee X

First Partial Valuation Period Earnings

15%

7501

Employee X

1999 Earnings

10%

5752

Employee X

Second Partial Valuation Period Earnings

12%

7593

Employee X

Total Amount Contributed

$7,084

1$5,000 x 15%
2$5,750($5,000 +750) × 10%
3$6,325($5,000 +750 +575) x 12%

### Example 25:

The facts are the same as in Example 23.
Earnings Adjustment on the Corrective
Contribution:

The earnings amount on the corrective contribution
is the same as in Example 23, but the earnings

amount is allocated using the bifurcated allocation
method. Thus, the earnings for the first partial valu-
ation period (March 31, 1998 to December 31, 1998)
and the earnings for 1999 are allocated to Employee
X. Accordingly, Employer L makes a contribution
on June 1, 2000 to the plan of $7,084
($5,000(1.15)(1.10)(1.12)). Employee X's account

balance as of December 31, 1999 is increased by
$6,325 ($5,000(1.15)(1.10)); and the December 31,
1999 account balances of employees (including
Employee X's increased account balance) will share
in estimated January 1, 2000 to June 1, 2000 earn-
ings on the corrective contribution equal to $759
($6,325(.12)). (See Table 3.)

TABLE 3 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate

Amount

Allocated to:

Corrective Contribution

$5,000

Employee X

First Partial Valuation Period Earnings

15%

7501

Employee X

1999 Earnings

10%

5752

Employee X

Second Partial Valuation Period

12%

7593

12/31/99 Account Balances Earnings (including Employee X's $6,325)4

Total Amount Contributed

$7,084

1$5,000 x 15%

2$5,750($5,000 +750) x 10%

3$6,325($5,000 +750 +575) x 12%

4 After reduction for distributions during the 2000 year but without regard to contributions received during the 2000 year .

### Example 26:

The facts are the same as in Example 23.

Earnings Adjustment on the Corrective
Contribution:

The earnings amount on the corrective contribu-
tion is the same as in Example 23, but the earn-
ings amount is allocated using the current period
allocation method. Thus, the earnings for the first
partial valuation period (March 31, 1998 to
December 31, 1998) are allocated as 2000 earn-

ings. Accordingly, Employer L makes a contri-
bution on June 1, 2000 to the plan of $7,084
($5,000 (1.15)(1.10)(1.12)). Employee X's
account balance as of December 31, 1999, is
increased by the sum of $5,500 ($5,000(1.10))
and the remaining 1999 earnings on the correc-
tive contribution equal to $75 ($5,000(.15)(.10)).
Further, both (1) the estimated March 31, 1998 to
December 31, 1998 earnings on the corrective
contribution equal to $750 ($5,000(.15)) and (2)

the estimated January 1, 2000 to June 1, 2000,
earnings on the corrective contribution equal to
$759 ($6,325(.12)) are treated in the same man-
ner as 2000 earnings by allocating these amounts
to the December 31, 2000, account balances of
employees in proportion to account balances as
of December 31, 1999 (including Employee X's
increased account balance). (See Table 4.) Thus,
Employee X is allocated the earnings for the full
valuation period during the period of the failure.

TABLE 4 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate

Amount

Allocated to:

Corrective Contribution

$5,000

Employee X

First Partial Valuation Period Earnings

15%

7501

12/31/99 Account Balances (including Employee X's $ 5,575)4

1999 Earnings

10%

5752

Employee X

Second Partial Valuation Period Earnings

12%

7593

12/31/99 Account Balances (including Employee X's $5,575)4

Total Amount Contributed

$7,084

1$5,000 x 15%

2$5,750($5,000 +750) x 10%

3$6,325($5,000 +750 +575) x 12%

4 After reduction for distributions during the year for which earnings are being determined but without regard to contributions received during the year for which
earnings are being determined.

# APPENDIX C VCP CHECKLIST IS YOUR SUBMISSION COMPLETE?

## INSTRUCTIONS

The Service will be able to respond more quickly to your VCP request if it is carefully prepared and complete. To ensure that your
request is in order, use this checklist. Answer each question in the checklist by inserting yes, no, or N/A, as appropriate, in the blank
next to the item. Sign and date the checklist (as taxpayer or authorized representative) and place it on top of your request.
You must submit a completed copy of this checklist with your request.

If a completed checklist is not submitted with your request, substantive consideration of your submission will be deferred until a
completed checklist is received.

TAXPAYER'S NAME

TAXPAYER'S I.D. NO.

PLAN NAME & NO.

ATTORNEY/P.O.A.

The following items relate to all submissions:

1\. Have you included a complete description of the failure(s) and the years in which the failure(s) oc-
curred (including the years for which the statutory period has expired)? (See section 11.02(1) of Rev.
Proc. 2001-17.) (Hereafter, all section references are to Rev. Proc. 2001-17.)

2\. Have you included an explanation of how and why the failure(s) arose, including a description of the ad-
ministrative procedures for the plan in effect at the time the failure(s) occurred? (See section 11.02(2) and (3).)

3\. Have you included a detailed description of the method for correcting the failure(s) identified in your
submission? This description must include, for example, the number of employees affected and the ex-
pected cost of correction (both of which may be approximated if the exact number cannot be determined
at the time of the request), the years involved, and calculations or assumptions the Plan Sponsor used to
determine the amounts needed for correction. In lieu of providing correction calculations with respect to
each employee affected by a failure, you may submit calculations with respect to a representative sample
of affected employees. However, the representative sample calculations must be sufficient to demon-
strate each aspect of the correction method proposed. Note that each step of the correction method must
be described in narrative form. (See section 11.02(4).)

4\. Have you described the earnings or interest methodology (indicating computation period and basis for
determining earnings or interest rates) that will be used to calculate earnings or interest on any corrective
contributions or distributions? (As a general rule, the interest rate (or rates) earned by the plan during the
applicable period(s) should be used in determining the earnings for corrective contributions or distribu-
tions.) (See section 11.02(5).)

If you inserted "N/A" for item 4, enter explanation:

5\. Have you submitted specific calculations for each affected employee or a representative sample of af-
fected employees? (See section 11.02(6).)

6\. Have you described the method that will be used to locate and notify former employees or, if there are
no former employees affected by the failure(s) or the correction(s), provided an affirmative statement to
that effect? (See section 11.02(7).)

7\. Have you provided a description of the administrative measures that have been or will be implemented
to ensure that the same failure(s) do not recur? (See section 11.02(8).)

8\. Have you included a statement that, to the best of the Plan Sponsor's knowledge, the plan is not cur-
rently under an Employee Plans examination? (See section 11.02(9).)

9\. Have you included a statement that, to the best of the Plan Sponsor's knowledge, the Plan Sponsor is
not under an Exempt Organizations examination? (See section 11.02(9).)

10\. Have you included a copy of the portions of the plan document (and adoption agreement, if applica-
ble) relevant to the failure(s) and method(s) of correction? (See section 11.04(2).)

11\. Have you included a copy of the plan's most recent Favorable Letter and/or the required applicable
document(s)? (See section 11.04(4).)

12\. Have you included the appropriate voluntary compliance fee due with the submission? (See section
11.06.)

13\. Have you included the original signature of the sponsor or the sponsor's authorized representative?
(See section 11.07.)

14\. Have you included a Power of Attorney (Form 2848)? Note: representation under VCP is limited to
attorneys, certified public accountants, enrolled agents, and enrolled actuaries; unenrolled return prepar-
ers are not eligible to act as representatives under VCP. (See section 11.08.)

15\. Have you included a Penalty of Perjury Statement signed (original signature only) and dated by the
Plan Sponsor? (See section 11.09.)

16\. Have you designated your submission as a VCP, VCO, VCS, VCT, VCSEP, VCGroup, or Anony-
mous Submission Procedure, as appropriate? (See section 11.11.)

The following items relate only to submissions under VCO (including VCS):

17\. If the plan is currently being considered in a determination letter application on a Form 5310, have
you included a statement to that effect? (See section 11.03(10).)

18\. Have you included a copy of the first page, the page containing employee census information (cur-
rently line 7f of the 1999 Form 5500), and the information relating to plan assets (currently line 31f of the
1999 Form 5500) of the most recently filed Form 5500 series return? Note: If a Form 5500 is not applic-
able, insert N/A and furnish the name of the plan, and the census information required of Form 5500 se-
ries filers. (See section 11.04(1)(b).)

19\. Have you proposed a time period of correction that is limited to 150 days (240 days for VCGroup)
from the date the compliance statement is issued? (See sections 10.06(8) and 10.14(3)(b).)

The following items relate only to submissions under VCS:

20\. Are each of the failures you have identified eligible for correction under VCS? (See Appendix A and
Appendix B.)

21\. Have you identified no more than two VCS failures? (If more than two failures were identified, VCS
is not available, but you may make a submission under VCO.) (See section 10.11(3).)

22\. Have you proposed to correct the failure(s) identified in your request using the permitted correction
method(s) set forth in Appendix A or Appendix B? (See Appendix A and Appendix B.)

The following items relates only to submissions under the general procedures of VCP:

24\. Have you included a copy of the most recently filed Form 5500? (See section 11.04(1)(b).)

25\. Have you submitted an application for a determination letter? (See section 11.05.)

Signature

Date

Title or Authority

Typed or printed name of person signing checklist

## Part IV. Items of General Interest

Notice of Proposed Rulemaking
by Cross-Reference to
Temporary Regulations

HIPAA Nondiscrimination
REG-114082-00

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed rulemak-
ing by cross-reference to temporary regu-
lations.

SUMMARY: In T.D. 8931 on page 542 of
this Bulletin, the IRS is issuing temporary
and final regulations governing the provi-
sions prohibiting discrimination based on
a health factor for group health plans. The
IRS is issuing the temporary and final reg-
ulations at the same time that the Pension
and Welfare Benefits Administration of
the U.S. Department of Labor and the
Health Care Financing Administration of
the U.S. Department of Health and
Human Services are issuing substantially
similar interim final regulations govern-
ing the provisions prohibiting discrimina-
tion based on a health factor for group
health plans and issuers of health insur-
ance coverage offered in connection with
a group health plan under the Employee
Retirement Income Security Act of 1974
and the Public Health Service Act. The
temporary regulations provide guidance
to employers and group health plans relat-
ing to the group health plan nondiscrimi-
nation requirements. The text of those
temporary regulations also serves as the
text of these proposed regulations.

DATES: Written comments and requests
for a public hearing must be received by
April 9, 2001.

ADDRESSES: Send submissions to:
CC:M&SP:RU (REG-114082-00), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand-
delivered to: CC:M&SP:RU (REG-
114082-00), room 5226, Internal
Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC.

Alternatively, taxpayers may submit com-
ments electronically via the Internet by

selecting the "Tax Regs" option on the
IRS Home Page, or by submitting com-
ments directly to the IRS Internet site at:
http://www.irs.gov/tax_regs/regslist.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Russ
Weinheimer at 202-622-6080; concerning
submissions of comments or requests for
a hearing, Sonya Cruse at 202-622-7190
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

### Paperwork Reduction Act

The collection of information refer-
enced in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in
accordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)).

An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.

The collections of information are in
§54.9802-1T (see the temporary regula-
tions published elsewhere in this issue of
the Bulletin). The collections of informa-
tion are required so that individuals
denied enrollment in a group health plan
based on one or more health factors will
be apprised of their right to enroll in the
plan without regard to their health. The
likely respondents are business or other
for-profit institutions, nonprofit institu-
tions, small businesses or organizations,
and Taft-Hartley trusts. Responses to this
collection of information are required of
plans that have denied enrollment to indi-
viduals based on one or more health fac-
tors.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.

Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of the
Treasury, Office of Information and

Regulatory Affairs, Washington, DC
20503, with copies to the Internal
Revenue Service, Attn: IRS Reports
Clearance Officer, W:CAR:MP:FP:S:O,
Washington, DC 20224. Comments on
the collection of information should be
received by April 9, 2001. Comments are
specifically requested concerning:

. Whether the proposed collection of
information is necessary for the
proper performance of the functions
of the Internal Revenue Service,
including whether the information
will have practical utility;

· The accuracy of the estimated bur-
den associated with the proposed
collection of information (see the
preamble to the temporary regula-
tions published elsewhere in this
issue of the Bulletin);

· How to enhance the quality, utility,
and clarity of the information to be
collected;

· How to minimize the burden of
complying with the proposed collec-
tion of information, including the
application of automated collection
techniques or other forms of infor-
mation technology; and

· Estimates of capital or start-up costs
and costs of operation, maintenance,
and purchase of services to provide
information.

### Background

The temporary regulations published in
T.D. 8931 add a new §54.9802-1T to the
Miscellaneous Excise Tax Regulations.1
When these proposed regulations are pub-
lished as final regulations, they will sup-
plement the final regulations in
§54.9802-1 published in T.D. 8931. The
proposed, temporary, and final regulations

1 A previous §54.9802-1T was published in the
Federal Register on April 8, 1997. By operation of
section 7805(e) of the Internal Revenue Code, the
previous §54.9802-1T expired on April 8, 2000.
Proposed regulations containing the same text as
previous §54.9802-1T were also published on April
8, 1997, and final regulations based on those pro-
posed regulations are being published in the Federal
Register as §54.9802-1. The new §54.9802-1T
being published in T.D. 8931 consists almost entire-
ly of new guidance not contained in the previous
§54.9802-1T.

are being published as part of a joint rule-
making with the Department of Labor and
the Department of Health and Human
Services (the joint rulemaking).

The text of those temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains the temporary
regulations.

### Special Analyses

This regulation is not subject to the
Unfunded Mandates Reform Act of 1995
because the regulation is an interpretive
regulation. It has also been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to this regulation. For further
information and for analyses relating to
the joint rulemaking, see the preamble to
the joint rulemaking. Pursuant to section
7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its impact
on small business.

## Comments and Requests for a Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments (a
signed original and eight (8) copies) that
are submitted timely to the IRS.
Comments are specifically requested on
the clarity of the proposed regulations and
how they may be made easier to under-
stand. All comments will be available for
public inspection and copying. A public
hearing may be scheduled if requested in
writing by a person that timely submits
written comments. If a public hearing is
scheduled, notice of the date, time, and
place for the hearing will be published in
the Federal Register.

## Drafting Information

The principal author of these proposed
regulations is Russ Weinheimer, Office of
the Operating Division Counsel/Associate
Chief Counsel (Tax Exempt and
Government Entities), IRS. However,
other personnel from the IRS and
Treasury Department participated in their
development. The proposed regulations,
as well as the temporary regulations, have

been developed in coordination with per-
sonnel from the U.S. Department of Labor
and the U.S. Department of Health and
Human Services.

* * * * *

## Proposed Amendments to the Regulations

Accordingly, 26 CFR part 54 is pro-
posed to be amended as follows:

### PART 54-PENSION EXCISE TAXES

Paragraph 1. The authority citation for
part 54 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 54.9802-1 is amended
to read as follows:

§54.9802-1 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

[The text of the proposed amendments
to this section is the same as the text of
§54.9802-1T published in T.D. 8931].

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.

(Filed by the Office of the Federal Register on
January 5, 2001, 8:45 a.m., and published in the
issue of the Federal Register for January 8, 2001, 66
F.R. 1435)

## Notice of Proposed Rulemaking

## Exception to the HIPAA Nondiscrimination Requirements for Certain Grandfathered Church Plans

REG-114083-00

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed rulemak-
ing.

SUMMARY: This document contains
proposed regulations that provide guid-
ance under section 9802(c) of the Internal
Revenue Code relating to the exception
for certain grandfathered church plans
from the nondiscrimination requirements
applicable to group health plans under
section 9802(a) and (b). Final, temporary,
and proposed regulations (T.D. 8931,

REG-114082-00, and REG-114084-00)
relating to the nondiscrimination require-
ments under section 9802(a) and (b) are
being published on pages 542, 631, and
635 in this issue of the Bulletin. The
regulations will generally affect sponsors
of and participants in certain self-funded
church plans that are group health plans,
and the regulations provide plan sponsors
and plan administrators with guidance
necessary to comply with the law.

DATES: Written or electronic comments
and requests for a public hearing must be
received by April 9, 2001.

ADDRESSES: Send Submissions to:
CC:M&SP:RU (REG-114083-00), room
5226, Internal Revenue Service, POB 7604,
Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered
between the hours of 8 a.m. and 5 p.m. to:
CC:M&SP:RU (REG-114083-00), Cou-
rier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC.
Alternatively, taxpayers may submit com-
ments electronically via the Internet by
selecting the "Tax Regs" option on the IRS
Home Page, or by submitting comments
directly to the IRS Internet site at:
http://www.irs.gov/tax_regs/regslist.html.

FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Russ
Weinheimer at 202-622-6080; concerning
submissions of comments or requests for
a hearing, Sonya Cruse at 202-622-7190
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

### Background

This document contains proposed
amendments to the Miscellaneous Excise
Tax Regulations (26 CFR part 54) relating
to the exception for certain grandfathered
church plans from the nondiscrimination
requirements applicable to group health
plans. The nondiscrimination require-
ments applicable to group health plans
were added to the Internal Revenue Code
(Code), in section 9802, by the Health
Insurance Portability and Accountability
Act of 1996 (HIPAA), Public Law 104-
191. HIPAA also added similar nondis-
crimination provisions applicable to
group health plans and health insurance
issuers (such as health insurance compa-
nies and health maintenance organiza-
tions) under the Employee Retirement

Income Security Act of 1974 (ERISA),
administered by the U.S. Department of
Labor, and the Public Health Service Act
(PHS Act), administered by the U.S.
Department of Health and Human
Services.

Final and temporary regulations relat-
ing to the HIPAA nondiscrimination
requirements in paragraphs (a) and (b) of
section 9802 of the Code are being pub-
lished in T.D. 8931 on page 542 of this
Bulletin. Those regulations are similar to,
and have been developed in coordination
with, interim final regulations also being
published today by the Departments of
Labor and Health and Human Services.
Guidance under the HIPAA nondiscrimi-
nation requirements is summarized in a
joint preamble to the final, interim final,
and temporary regulations.

The exception for certain grandfathered
church plans was added to section 9802,
in a new subsection (c), by section 1532
of the Taxpayer Relief Act of 1997, Public
Law 105-34. These proposed regulations
would provide guidance for this excep-
tion. The guidance is summarized in the
explanation below.

### Explanation of Provisions

Church plans that are group health
plans are generally subject to the Code
provisions in Chapter 100 relating to
access, portability, and renewability.1
However, under section 9802(c), church
plans satisfying certain requirements con-
tinuously since July 15, 1997 are not treat-
ed as failing to meet the section 9802 pro-
hibitions against discrimination based on
any health factor solely because the plan
requires evidence of good health for the
coverage of certain individuals.

The grandfather rule in section 9802(c)
applies to a church plan for a plan year
only if, on July 15, 1997 and at all times
after that date before the beginning of the
plan year, the church plan had provisions
satisfying one of two alternative condi-
tions. The first alternative condition is
that the plan contain provisions requiring
evidence of good health of two sets of
individuals, that is, both (1) any employee
of an employer with 10 or fewer employ-
ees and (2) any self-employed individual.
The proposed regulations specify that this
condition is not satisfied if the plan
requires evidence of good health of only
one of these sets of individuals. The pro-

posed regulations also clarify that the plan
provision for the first set of individuals
must be exactly 10 or fewer. Thus, a plan
provision requiring evidence of good
health for employees of an employer of
fewer than 10, or of greater than 10,
employees does not satisfy this condition.
For example, a plan provision requiring
evidence of good health of any employee
of an employer of five or fewer employ-
ees does not satisfy this condition.

The second alternative condition is that
the plan contain provisions requiring evi-
dence of good health of any individual
who enrolls after the first 90 days of ini-
tial eligibility. The proposed regulations
clarify that the period for these plan pro-
visions must be exactly 90 days. Thus, a
plan provision requiring evidence of good
health of any individual who enrolls after
the first 120 days of initial eligibility does
not satisfy this condition.

The grandfather rule in section
9802(c) of the Code is not by its terms
limited in its application to self-funded
church plans. Section 2702 of the Public
Health Service Act (PHS Act) imposes
nondiscrimination requirements on
health insurance issuers offering group
health insurance coverage, and those
nondiscrimination requirements are gen-
erally similar to the nondiscrimination
requirements imposed on group health
plans (including church plans) under
paragraphs (a) and (b) of section 9802 of
the Code. However, section 2702 of the
PHS Act does not include an exception
for health insurance issuers offering
group health insurance coverage to
church plans comparable to the excep-
tion for church plans in section 9802(c)
of the Code. Thus, if a church plan pro-
viding benefits through group health
insurance coverage were to require evi-
dence of good health of certain individ-
uals as permitted under section 9802(c)
of the Code, the requirement of evidence
of good health would cause the health
insurance issuer providing the coverage
to violate the nondiscrimination require-
ments of the PHS Act. In such a case,
the sanctions under the PHS Act would
apply to the issuer, but those under the
Code would not apply to the church
plan. Thus, assuming that group health
insurance coverage complies with the
nondiscrimination requirements of the
PHS Act, the rule in section 9802(c) of

the Code is, in effect, available only to
church plans that are not funded through
group health insurance because only
such church plans do not include insur-
ance coverage that is subject to Title
XXVII of the PHS Act. Accordingly, the
examples in the proposed regulations
illustrating situations where section
9802(c) is available are limited to group
health plans that are not funded through
group health insurance in order to avoid
misleading insured church plans about
the availability of the grandfather rule in
section 9802(c).

### Special Analyses

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a reg-
ulatory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations, and because the regulations
do not impose a collection of information
requirement on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Therefore, a
Regulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemaking
will be submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its impact
on small business.

## Comments and Requests for a Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments
that are submitted timely (a signed origi-
nal and eight (8) copies) to the IRS.
Comments are specifically requested on
the clarity of the proposed regulations and
how they may be made easier to under-
stand. All comments will be available for
public inspection and copying. A public
hearing may be scheduled if requested in
writing by a person that timely submits
written comments. If a public hearing is
scheduled, notice of the date, time, and
place for the hearing will be published in
the Federal Register.

## Drafting Information

The principal author of these proposed
regulations is Russ Weinheimer, Office of
the Operating Division Counsel/Associate
Chief Counsel (Tax Exempt and
Government Entities). However, other
personnel from the IRS and Treasury
Department participated in their develop-
ment.

* * * * *

## Proposed Amendments to the Regulations

Accordingly, 26 CFR part 54 is pro-
posed to be amended as follows:

## PART 54 - PENSION EXCISE TAXES

Paragraph 1. The authority citation for
part 54 is amended in part by adding an
entry in numerical order to read as fol-
lows:

Authority: 26 U.S.C. 7805

Section 54.9802-2 also issued under 26
U.S.C. 9802. * * *

Par. 2. Section 54.9802-2 is added to
read as follows:

§54.9802-2 Special rules for certain
church plans.

(a) Exception for certain church
plans-(1) Church plans in general. A
church plan described in paragraph (b) of
this section is not treated as failing to
meet the requirements of section 9802 or
§§54.9802-1 and 54.9802-1T solely
because the plan requires evidence of
good health for coverage of individuals
under plan provisions described in para-
graph (b)(2) or (3) of this section.

(2) Health insurance issuers. See sec-
tions 2702 and 2721(b)(1)(B) of the Public
Health Service Act (42 U.S.C. 300gg-2
and 300gg-21(b)(1)(B)) and 45 CFR
146.121, which require health insurance
issuers providing health insurance cover-
age under a church plan that is a group
health plan to comply with nondiscrimina-
tion requirements similar to those that
church plans are required to comply with
under section 9802 and §§54.9802-1 and
54.9802-1T except that those nondiscrimi-
nation requirements do not include an
exception for health insurance issuers com-
parable to the exception for church plans
under section 9802(c) and this section.

(b) Church plans to which this section
applies-(1) Church plans with certain

coverage provisions in effect on July 15,
1997. This section applies to any church
plan (as defined in section 414(e)) for a
plan year if, on July 15, 1997 and at all
times thereafter before the beginning of
the plan year, the plan contains either the
provisions described in paragraph (b)(2)
of this section or the provisions described
in paragraph (b)(3) of this section.

(2) Plan provisions applicable to indi-
viduals employed by employers of 10 or
fewer employees and self-employed indi-
viduals-(i) A plan contains the provi-
sions described in this paragraph (b)(2) if
it requires evidence of good health of
both -

(A) Any employee of an employer of
10 or fewer employees (determined with-
out regard to section 414(e)(3)(C), under
which a church or convention or associa-
tion of churches is treated as the employ-
er); and

(B) Any self-employed individual.

(ii) A plan does not contain the provi-
sions described in this paragraph (b)(2) if
the plan contains only one of the provi-
sions described in this paragraph (b)(2).
Thus, for example, a plan that requires
evidence of good health of any self-
employed individual, but not of any
employee of an employer with 10 or
fewer employees, does not contain the
provisions described in this paragraph
(b)(2). Moreover, a plan does not contain
the provision described in paragraph
(b)(2)(i)(A) of this section if the plan
requires evidence of good health of any
employee of an employer of fewer than 10
(or greater than 10) employees. Thus, for
example, a plan does not contain the pro-
vision described in paragraph (b)(2)(i)(A)
of this section if the plan requires evi-
dence of good health of any employee of
an employer with five or fewer employ-
ees.

(3) Plan provisions applicable to indi-
viduals who enroll after the first 90 days
of initial eligibility-(i) A plan contains
the provisions described in this paragraph
(b)(3) if it requires evidence of good
health of any individual who enrolls after
the first 90 days of initial eligibility under
the plan.

(ii) A plan does not contain the provi-
sions described in this paragraph (b)(3) if
it provides for a longer (or shorter) period
than 90 days. Thus, for example, a plan
requiring evidence of good health of any
individual who enrolls after the first 120

days of initial eligibility under the plan
does not contain the provisions described
in this paragraph (b)(3).

Example 1. (i) Facts. A church organization
maintains two church plans for entities affiliated with
the church. One plan is a group health plan that pro-
vides health coverage to all employees (including
ministers and lay workers) of any affiliated church
entity that has more than 10 employees. The other
plan is Plan O, which is a group health plan that is not
funded through insurance coverage and that provides
health coverage to any employee (including ministers
and lay workers) of any affiliated church entity that
has 10 or fewer employees and any self-employed
individual affiliated with the church (including a self-
employed minister of the church). Plan O requires
evidence of good health in order for any individual of
a church entity that has 10 or fewer employees to be
covered and in order for any self-employed individual
to be covered. On July 15, 1997, and at all times
thereafter before the beginning of the plan year, Plan
O has contained all the preceding provisions.

(ii) Conclusion. In this Example 1, because Plan
O contains the plan provisions described in para-
graph (b)(2) of this section and because those pro-
visions were in the plan on July 15, 1997, and at all
times thereafter before the beginning of the plan
year, Plan O will not be treated as failing to meet
the requirements of section 9802, §54.9802-1, or
§54.9802-1T for the plan year solely because the
plan requires evidence of good health for coverage
of the individuals described in those plan provi-
sions.

Example 2. (i) Facts. A church organization
maintains Plan P, which is a church plan that is not
funded through insurance coverage and that is a
group health plan providing health coverage to indi-
viduals employed by entities affiliated with the
church and self-employed individuals affiliated with
the church (such as ministers). On July 15, 1997,
and at all times thereafter before the beginning of the
plan year, Plan P has required evidence of good
health for coverage of any individual who enrolls
after the first 90 days of initial eligibility under the
plan.

(ii) Conclusion. In this Example 2, because Plan
P contains the plan provisions described in para-
graph (b)(3) of this section and because those provi-
sions were in the plan on July 15, 1997, and at all
times thereafter before the beginning of the plan
year, Plan P will not be treated as failing to meet the
requirements of section 9802, §54.9802-1, or
§54.9802-1T for the plan year solely because the
plan requires evidence of good health for coverage
of individuals enrolling after the first 90 days of ini-
tial eligibility under the plan.

(d) Effective date. [Reserved]

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.

(Filed by the Office of the Federal Register on Janu-
ary 5, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 8, 2001, 66 F.R.
1437)

## Notice of Proposed Rulemaking and Request for Comments

## Notice of Proposed Rulemaking for Bona Fide Wellness Programs

REG-114084-00

ACTION: Notice of proposed rulemaking
and request for comments.

SUMMARY: This proposed rule would
implement and clarify the term "bona fide
wellness program" as it relates to regula-
tions implementing the nondiscrimination
provisions of the Internal Revenue Code,
the Employee Retirement Income
Security Act, and the Public Health
Service Act, as added by the Health
Insurance Portability and Accountability
Act of 1996.

DATES: Written comments on this notice
of proposed rulemaking are invited and
must be received by the Departments on
or before April 9, 2001.

ADDRESSES: Written comments
should be submitted with a signed origi-
nal and three copies (except for electron-
ic submissions to the Internal Revenue
Service (IRS) or Department of Labor) to
any of the addresses specified below.
Any comment that is submitted to any
Department will be shared with the other
Departments.

Comments to the IRS can be addressed
to:
CC:M&SP:RU (REG-114084-00)
Room 5226
Internal Revenue Service
POB 7604, Ben Franklin Station
Washington, DC 20044

In the alternative, comments may be
hand-delivered between the hours of 8
a.m. and 5 p.m. to:
CC:M&SP:RU (REG-114084-00)
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, NW.
Washington, DC 20224

Alternatively, comments may be transmit-
ted electronically via the IRS Internet site
at:

http://www.irs.gov/tax_regs/regslist.html.

Comments to the Department of Labor
can be addressed to:

U.S. Department of Labor

Pension and Welfare Benefits
Administration
200 Constitution Avenue NW.,
Room C-5331
Washington, DC 20210

Attention: Wellness Program Comments

Alternatively, comments may be hand-
delivered between the hours of 9 a.m. and
5 p.m. to the same address. Comments
may also be transmitted by e-mail to:
Wellness@pwba.dol.gov.

Comments to HHS can be addressed to:
Health Care Financing Administration
Department of Health and Human
Services
Attention: HCFA-2078-P
P.O. Box 26688
Baltimore, MD 21207

In the alternative, comments may be
hand-delivered between the hours of 8:30
a.m. and 5 p.m. to either:

Room 443-G
Hubert Humphrey Building
200 Independence Avenue, SW.
Washington, DC 20201
or
Room C5-14-03
7500 Security Boulevard
Baltimore, MD 21244-1850

All submissions to the IRS will be open to
public inspection and copying in room
1621, 1111 Constitution Avenue, NW.,
Washington, DC from 9 a.m. to 4 p.m.

All submissions to HHS will be open to
public inspection and copying in room
309-G of the Department of Health and
Human Services, 200 Independence

Avenue, SW., Washington, DC from 8:30
a.m. to 5 p.m.

FOR FURTHER INFORMATION CON-
TACT: Russ Weinheimer, Internal
Revenue Service, Department of the
Treasury, at (202) 622-6080; Amy J.
Turner, Pension and Welfare Benefits
Administration, Department of Labor, at
(202) 219-4377; or Ruth A. Bradford,
Health Care Financing Administration,
Department of Health and Human
Services, at (410) 786-1565.

CUSTOMER SERVICE INFORMATION:
Individuals interested in obtaining addition-
al information on HIPAA's nondiscrimina-
tion rules may request a copy of the
Department of Labor's booklet entitled
"Questions and Answers: Recent Changes
in Health Care Law" by calling the PWBA
Toll-Free Publication Hotline at 1-800-998-
7542 or may request a copy of the Health
Care Financing Administration's new pub-
lication entitled "Protecting Your Health
Insurance Coverage" by calling (410) 786-
1565. Information on HIPAA's nondis-
crimination rules and other recent health
care laws is also available on the
Department of Labor's website
(http://www.dol.gov/dol/pwba) and the
Department of Health and Human
Services' website (http://hipaa.hcfa.gov).

SUPPLEMENTARY INFORMATION:

### I. Background

The Health Insurance Portability and
Accountability Act of 1996 (HIPAA),
Public Law 104-191, was enacted on
August 21, 1996. HIPAA amended the
Internal Revenue Code of 1986 (Code),
the Employee Retirement Income
Security Act of 1974 (ERISA), and the
Public Health Service Act (PHS Act) to
provide for, among other things, improved
portability and continuity of health cover-
age. HIPAA added section 9802 of the
Code, section 702 of ERISA, and section
2702 of the PHS Act, which prohibit dis-
crimination in health coverage. However,
the HIPAA nondiscrimination provisions
do not prevent a plan or issuer from estab-
lishing discounts or rebates or modifying
otherwise applicable copayments or
deductibles in return for adherence to pro-
grams of health promotion and disease
prevention. Interim final rules imple-
menting the HIPAA provisions were first

made available to the public on April 1,
1997 (published in the Federal Register
on April 8, 1997, 62 F.R. 16894) (April
1997 interim rules).

In the preamble to the April 1997 inter-
im rules, the Departments invited com-
ments on whether additional guidance
was needed concerning, among other
things, the permissible standards for
determining bona fide wellness programs.
The Departments also stated that they
intend to issue further regulations on the
nondiscrimination rules and that in no
event would the Departments take any
enforcement action against a plan or
issuer that had sought to comply in good
faith with section 9802 of the Code, sec-
tion 702 of ERISA, and section 2702 of
the PHS Act before the additional guid-
ance is provided. The new interim regu-
lations relating to the HIPAA nondiscrim-
ination rules (published in T.D. 8931 on
page 542 of this Bulletin) do not include
provisions relating to bona fide wellness
programs. Accordingly, the period for
good faith compliance continues with
respect to those provisions until further
guidance is issued. Compliance with the
provisions of these proposed regulations
constitutes good faith compliance with the
statutory provisions relating to wellness
programs.

## II. Overview of the Proposed Regulations

The HIPAA nondiscrimination provi-
sions generally prohibit a plan or issuer
from charging similarly situated individu-
als different premiums or contributions
based on a health factor. In addition,
under the interim regulations in T.D.
8931, cost-sharing mechanisms such as
deductibles, copayments, and coinsurance
are considered restrictions on benefits.
Thus, they are subject to the same rules as
are other restrictions on benefits; that is,
they must apply uniformly to all similarly
situated individuals and must not be
directed at individual participants or ben-
eficiaries based on any health factor of the
participants or beneficiaries. However,
the HIPAA nondiscrimination provisions
do not prevent a plan or issuer from estab-
lishing premium discounts or rebates or
modifying otherwise applicable copay-
ments or deductibles in return for adher-
ence to programs of health promotion and
disease prevention. Thus, there is an

exception to the general rule prohibiting
discrimination based on a health factor if
the reward, such as a premium discount or
waiver of a cost-sharing requirement, is
based on participation in a program of
health promotion or disease prevention.
The April 1997 interim rules, the interim
regulations published in T.D. 8931, and
these proposed regulations refer to pro-
grams of health promotion and disease
prevention allowed under this exception
as "bona fide wellness programs." In
order to prevent the exception to the
nondiscrimination requirements for bona
fide wellness programs from eviscerating
the general rule contained in the HIPAA
nondiscrimination provisions, these pro-
posed regulations impose certain require-
ments on wellness programs providing
rewards that would otherwise discrimi-
nate based on a health factor.

A wide range of wellness programs
exist to promote health and prevent dis-
ease. However, many of these programs
are not subject to the bona fide wellness
program requirements. The requirements
for bona fide wellness programs apply
only to a wellness program that provides a
reward based on the ability of an individ-
ual to meet a standard that is related to a
health factor, such as a reward condi-
tioned on the outcome of a cholesterol
test. Therefore, without having to comply
with the requirements for a bona fide
wellness program, a wellness program
could -

· Provide voluntary testing of enrollees
for specific health problems and
make recommendations to address
health problems identified, if the pro-
gram did not base any reward on the
outcome of the health assessment;

· Encourage preventive care through
the waiver of the copayment or
deductible requirement for the costs
of well-baby visits;

· Reimburse employees for the cost of
health club memberships, without
regard to any health factors relating
to the employees; or

·· Reimburse employees for the costs of
smoking cessation programs, without
regard to whether the employee quits
smoking.

A wellness program that provides a
reward based on the ability of an individ-
ual to meet a standard related to a health
factor violates the interim regulations

published in T.D. 8931 unless it is a bona
fide wellness program. Under these pro-
posed regulations, a wellness program
must meet four requirements to be a bona
fide wellness program.

First, the total reward that may be given
to an individual under the plan for all
wellness programs is limited. A reward
can be in the form of a discount, a rebate
of a premium or contribution, or a waiver
of all or part of a cost-sharing mechanism
(such as deductibles, copayments, or coin-
surance), or the absence of a surcharge.
The reward for the wellness program,
coupled with the reward for other well-
ness programs with respect to the plan
that require satisfaction of a standard
related to a health factor, must not exceed
a specified percentage of the cost of
employee-only coverage under the plan.
The cost of employee-only coverage is
determined based on the total amount of
employer and employee contributions for
the benefit package under which the
employee is receiving coverage.

The proposed regulations specify three
alternative percentages: 10, 15, and 20.
The Departments welcome comments on
the appropriate level for the percentage.
Comments will be taken into account in
determining the standard for the final reg-
ulations.

Several commenters on the April 1997
regulations suggested that the amount of a
reward should be permitted if it is actuar-
ially determined based on the costs asso-
ciated with the health factor measured
under the wellness program. However, in
some cases, the resulting reward (or
penalty) might be so large as to have the
effect of denying coverage to certain indi-
viduals. The percentage limitation in the
proposed regulations is designed to avoid
this result. The percentage limitation also
avoids the additional administrative costs
of a reward based on actuarial cost.

The Departments recognize that there
may be some programs that currently
offer rewards, individually or in the
aggregate, that exceed the specified per-
centage. However, as noted below in the
economic analysis, data is scarce regard-
ing practices of wellness programs. Thus,
the Departments specifically request com-
ments on the appropriateness of the spec-
ified percentage of the cost of employee-
only coverage under a plan as the
maximum reward for a bona fide wellness

program, including whether a larger
amount should be allowed for wellness
programs that include participation by
family members (i.e., the specified per-
centage of the cost of family coverage).
Note also that, as stated above, the period
for good faith compliance continues with
respect to whether wellness programs sat-
isfy the statutory requirements. While
compliance with these proposed regula-
tions constitutes good faith compliance
with the statutory provisions, it is possible
that, based on all the facts and circum-
stances, a plan's wellness program that
provides a reward in excess of the speci-
fied range of percentages of the cost of
employee-only coverage may also be
found to meet the good faith compliance
standard.

Under these proposed regulations, the
second requirement to be a bona fide
wellness program is that the program
must be reasonably designed to promote
good health or prevent disease for indi-
viduals in the program. This requirement
prevents a program from being a sub-
terfuge for merely imposing higher costs
on individuals based on a health factor by
requiring a reasonable connection
between the standard required under the
program and the promotion of good health
and disease prevention. Among other
things, a program is not reasonably
designed to promote good health or pre-
vent disease unless the program gives
individuals eligible for the program the
opportunity to qualify for the reward
under the program at least once per year.
In contrast, a program that imposes a
reward or penalty for the duration of the
individual's participation in the plan
based solely on health factors present
when an individual first enrolls in a plan
is not reasonably designed to promote
health or prevent disease (because, if the
individual cannot qualify for the reward
by adopting healthier behavior after initial
enrollment, the program does not have
any connection to improving health).

The third requirement to be a bona fide
wellness program under these proposed
regulations is that the reward under the
program must be available to all similarly
situated individuals. The April 1997
interim rules provided that if, under the
design of the wellness program, enrollees
might not be able to achieve a program
standard due to a health factor, the pro-

gram would not be a bona fide wellness
program. These proposed regulations
increase flexibility for plans by allowing
plans to make individualized adjustments
to their wellness programs to address the
health factors of the particular individuals
for whom it is unreasonably difficult to
qualify for the benefits under the program.
Specifically, the program must allow any
individual for whom it is unreasonably
difficult due to a medical condition (or for
whom it is medically inadvisable to
attempt) to satisfy the initial program
standard an opportunity to satisfy a rea-
sonable alternative standard. The exam-
ples clarify that a reasonable alternative
standard must take into account the rele-
vant health factor of the individual who
needs the alternative. A program does not
need to establish the specific reasonable
alternative standard before the program
commences. To satisfy this third require-
ment for being a bona fide wellness pro-
gram, it is sufficient to determine a rea-
sonable alternative standard once a
participant informs the plan that it is
unreasonably difficult for the participant
due to a medical condition to satisfy the
general standard (or that it is medically
inadvisable for the participant to attempt
to achieve the general standard) under the
program.

Many commenters asked how the bona
fide wellness program requirements apply
to programs that provide a reward for not
smoking. An example in the proposed
regulations clarifies that if it is unreason-
ably difficult for an individual to stop
smoking due to an addiction to nicotine1,
the individual must be provided a reason-
able alternative standard to obtain the
reward.

The fourth requirement to be a bona
fide wellness program under the proposed
regulations is that all plan materials
describing the terms of the program must
disclose the availability of a reasonable
alternative standard. The proposed regu-
lations include model language that can

1 Under the Diagnostic and Statistical Manual of
Mental Disorders, Fourth Edition, American
Psychiatric Association, 1994 (DSM IV), nicotine
addiction is a medical condition. See also Rev. Rul.
99-28, 1999-1 C.B. 1269 (June 21, 1999), citing a
report of the Surgeon General stating that scientists
in the field of drug addiction agree that nicotine, a
substance common to all forms of tobacco, is a pow-
erfully addictive drug.

be used to satisfy this requirement; exam-
ples also illustrate substantially similar
language that would satisfy the require-
ment.

The proposed regulations contain two
clarifications of this fourth requirement.
First, plan materials are not required to
describe specific reasonable alternative
standards. It is sufficient to disclose that
some reasonable alternative standard will
be made available. Second, any plan
materials that describe the general stan-
dard would also have to disclose the avail-
ability of a reasonable alternative stan-
dard. However, if the program is merely
mentioned (and does not describe the gen-
eral standard), disclosure of the availabil-
ity of a reasonable alternative standard is
not required.

## III. Economic Impact and Paperwork Burden

### Summary - Department of Labor and Department of Health and Human Services

Under the proposed regulation, health
plans generally may vary employee premi-
um contributions or benefit levels across
similarly situated individuals based on
health status factors only in connection with
bona fide wellness programs. The regula-
tion establishes four requirements for such
bona fide wellness programs. It (1) limits
the permissible amount of variation in
employee premium or benefit levels; (2)
requires that programs be reasonably
designed to promote health or prevent dis-
ease; (3) requires programs to permit plan
participants who for medical reasons would
incur unreasonable difficulty to satisfy the
programs' initial wellness standards to sat-
isfy reasonable alternative standards
instead; and (4) requires certain plan mate-
rials to disclose the availability of such
alternative standards. The Departments
carefully considered the costs and benefits
attendant to these requirements. The
Departments believe that the benefits of
these requirements exceed their costs.

The Departments anticipate that the
proposed regulation will result in transfers
of cost among plan sponsors and partici-
pants and in new economic costs and ben-
efits.

Economic benefits will flow from plan
sponsors' efforts to maintain wellness pro-
grams' effectiveness where discounts or

surcharges are reduced and from plans
sponsors' provision of reasonable alterna-
tive standards that help improve affected
plan participants' health habits and health.
The result will be fewer instances where
wellness programs merely shift costs to
high risk individuals and more instances
where they succeed at improving such
individuals' health habits and health.

Transfers will arise because the size of
some discounts and surcharges will be
reduced, and because some plan partici-
pants who did not satisfy wellness pro-
grams' initial standards will satisfy alter-
native standards. These transfers are
estimated to total between $18 million
and $46 million annually. (The latter fig-
ure is an upper bound, reflecting the case
in which all eligible participants pursue
and satisfy alternative standards.)

New economic costs may be incurred if
reductions in discounts or surcharges
reduce wellness programs' effectiveness,
but this effect is expected to be very small
because reductions will be small and rela-
tively few plans and participants will be
affected. Other new economic costs will be
incurred by plan sponsors to make available
reasonable alternative standards where
required. The Departments were unable to
estimate these costs but are confident that
these costs in combination with the trans-
fers referenced above will not exceed the
estimate of the transfers alone. Affected
plan sponsors can satisfy the proposed reg-
ulation's third requirement by making
available any reasonable standard they
choose, including low cost alternatives. It
is unlikely that plan sponsors would choose
alternative standards whose cost, in combi-
nation with costs transferred from partici-
pants who satisfy them, would exceed the
cost of providing discounts or waiving sur-
charges for all eligible participants.

#### Executive Order 12866 - Department of Labor and Department of Health and Human Services

Under Executive Order 12866, the
Departments must determine whether a reg-
ulatory action is "significant" and therefore
subject to the requirements of the Executive
Order and subject to review by the Office of
Management and Budget (OMB). Under
section 3(f), the order defines a "significant
regulatory action" as an action that is likely
to result in a rule (1) having an annual effect
on the economy of $100 million or more, or

adversely and materially affecting a sector
of the economy, productivity, competition,
jobs, the environment, public health or safe-
ty, or State, local or tribal governments or
communities (also referred to as “economi-
cally significant"); (2) creating serious
inconsistency or otherwise interfering with
an action taken or planned by another
agency; (3) materially altering the budgetary
impacts of entitlement grants, user fees, or
loan programs or the rights and obligations
of recipients thereof; or (4) raising novel
legal or policy issues arising out of legal
mandates, the President's priorities, or the
principles set forth in the Executive Order.

Pursuant to the terms of the Executive
Order, it has been determined that this
action raises novel policy issues arising out
of legal mandates. Therefore, this notice is
"significant" and subject to OMB review
under Section 3(f)(4) of the Executive
Order. Consistent with the Executive
Order, the Departments have assessed the
costs and benefits of this regulatory action.
The Departments' assessment, and the
analysis underlying that assessment, is
detailed below. The Departments per-
formed a comprehensive, unified analysis
to estimate the costs and benefits attribut-
able to the interim regulation for purposes
of compliance with Executive Order 12866,
the Regulatory Flexibility Act, and the
Paperwork Reduction Act.

### Statement of Need for Proposed Action

These interim regulations are needed to
clarify and interpret the HIPAA nondis-
crimination provisions (Prohibiting
Discrimination Against Individual
Participants and Beneficiaries Based on
Health Status) under Section 702 of the
Employee Retirement Income Security
Act of 1974 (ERISA), Section 2702 of the
Public Health Service Act, and Section
9802 of the Internal Revenue Code of
1986. The provisions are needed to
ensure that group health plans and group
health insurers and issuers do not discrim-
inate against individuals, participants, and
beneficiaries based on any health factors
with respect to health care premiums.
Additional guidance was required to
define bona fide wellness programs.

### Costs and Benefits

The Departments anticipate that the
proposed regulation will result in transfers
of cost among plans sponsors and partici-

pants and in new economic costs and ben-
efits. The economic benefits of the regu-
lation will include a reduction in instances
where wellness programs merely shift
costs to high risk individuals and an
increase in instances where they succeed
at improving such individuals' health
habits and health. Transfers are estimated
to total between $18 million and $46 mil-
lion annually. The Departments were
unable to estimate new economic costs
but are confident that these costs in com-
bination with the transfers referenced
above will not exceed the estimate of the
transfers alone. The Departments believe
that the regulation's benefits will exceed
its costs. Their unified analysis of the reg-
ulation's costs and benefits is detailed
later in this preamble.

### Regulatory Flexibility Act - Department of Labor and Department of Health and Human Services

The Regulatory Flexibility Act (5
U.S.C. 601 et seq.) (RFA) imposes certain
requirements with respect to Federal rules
that are subject to the notice and comment
requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C.
551 et seq.) and which are likely to have a
significant economic impact on a substan-
tial number of small entities. Unless an
agency certifies that a proposed rule will
not have a significant economic impact on
a substantial number of small entities, sec-
tion 603 of the RFA requires that the
agency present an initial regulatory flexi-
bility analysis (IRFA) at the time of the
publication of the notice of proposed rule-
making describing the impact of the rule
on small entities and seeking public com-
ment on such impact. Small entities
include small businesses, organizations
and governmental jurisdictions.

For purposes of analysis under the
RFA, PWBA proposes to continue to con-
sider a small entity to be an employee
benefit plan with fewer than 100 partici-
pants. The basis of this definition is found
in section 104(a)(2) of the Employee
Retirement Income Security Act of 1974
(ERISA), which permits the Secretary of
Labor to prescribe simplified annual
reports for pension plans which cover
fewer than 100 participants. Under sec-
tion 104(a)(3), the Secretary may also
provide for exemptions or simplified
annual reporting and disclosure for wel-

fare benefit plans. Pursuant to the author-
ity of section 104(a)(3), the Department of
Labor has previously issued at
29 C.F.R. §§ 2520.104-20, 2520.104-21,
2520.104-41, 2520.104-46 and
2520.104b-10 certain simplified report-
ing provisions and limited exemptions
from reporting and disclosure require-
ments for small plans, including unfunded
or insured welfare plans covering fewer
than 100 participants and which satisfy
certain other requirements.

Further, while some large employers
may have small plans, in general most
small plans are maintained by small
employers. Thus, PWBA believes that
assessing the impact of this proposed rule
on small plans is an appropriate substitute
for evaluating the effect on small entities.
For purposes of their unified IFRA, the
Departments adhered to PWBA's pro-
posed definition of small entities. The
definition of small entity considered
appropriate for this purpose differs, how-
ever, from a definition of small business
which is based on size standards promul-
gated by the Small Business
Administration (SBA) (13 CFR 121.201)
pursuant to the Small Business Act (15
U.S.C. 631 et seq.). The Departments
therefore request comments on the appro-
priateness of the size standard used in
evaluating the impact of this proposed
rule on small entities.

Under this proposed regulation, health
plans generally may vary employee pre-
mium contributions or benefit levels
across similarly situated individuals based
on health factors only in connection with
bona fide wellness programs. The regula-
tion establishes four requirements for
such bona fide wellness programs.

The Departments estimate that 36,000
plans with fewer than 100 participants
vary employee premium contributions or
benefit levels across similarly situated
individuals based on health factors.
While this represents just 1 percent of all
small plans, the Departments nonetheless
believe that it represents a substantial
number of small entities. The
Departments also note that at least some
premium discounts or surcharges may be
large. Premium discounts associated with
wellness programs are believed to range
as high as $560 per affected participant
per year. Therefore, the Departments
believe that the impact of this regulation

on at least some small entities may be sig-
nificant. Having reached these conclu-
sions, the Departments carried out an
IRFA as part of their unified analysis of
the costs and benefits of the regulation.
The reasoning and assumptions underly-
ing the Departments' unified analysis of
the regulation's costs and benefits are
detailed later in this preamble.

The regulation's first requirement caps
maximum allowable variation in employ-
ee premium contribution and benefit lev-
els. The Departments estimate that 9,300
small plans will be affected by the cap.
These plans can comply with this require-
ment by reducing premiums (or increas-
ing benefits) by $1.1 million on aggregate
for those participants whose premiums are
higher (or whose benefits are lower) due
to health factors. This would constitute an
ongoing, annual transfer of cost of $1.1
million, or $122 on average per affected
plan. The regulation does not limit small
plans' flexibility to transfer this cost back
evenly to all participants in the form of
small premium increases or benefit cuts.

The regulation's second requirement
provides that wellness programs must be
reasonably designed to promote health or
prevent disease. Comments received by
the Departments and available literature
on employee wellness programs suggest
that existing wellness programs generally
satisfy this requirement. The requirement
therefore is not expected to compel small
plans to modify existing wellness pro-
grams. It is not expected to entail eco-
nomic costs nor to prompt transfers.

The third requirement provides that
rewards under wellness programs must be
available to all similarly situated individ-
uals. In particular, programs must allow
individuals for whom it would be unrea-
sonably difficult due to a medical condi-
tion to satisfy initial program standards an
opportunity to satisfy reasonable alterna-
tive standards. The Departments believe
that some small plans' wellness programs
do not currently satisfy this requirement
and will have to be modified.

The Departments estimate that 21,000
small plans' wellness programs include
initial standards that may be unreasonably
difficult for some participants to meet.
These plans are estimated to include
18,000 participants for whom the standard
is in fact unreasonably difficult to meet.
(Many small plans are very small, having

fewer than 10 participants, and many will
include no participant for whom the initial
standard is unreasonable difficult to meet
for a medical reason.) Satisfaction of
alternative standards by these participants
will result in transfers of cost as they qual-
ify for discounts or escape surcharges. If
all of these participants request and then
satisfy an alternative standard, the transfer
would amount to $5 million annually. If
one-half request alternative standards and
one-half of those meet them, the transfer
would amount to $1 million.

In addition to transfers, small plans will
also incur new economic costs to provide
alternative standards. However, plans can
satisfy this requirement by providing
inexpensive alternative standards, and
have the flexibility to select whatever rea-
sonable alternative standard is most desir-
able or cost efficient. Plans not wishing to
provide alternative standards also have
the option of abolishing health-status
based variation in employee premiums.
The Departments expect that the econom-
ic cost to provide alternatives combined
with the associated transfer cost of granti-
ng discounts or waiving surcharges will
not exceed the transfer cost associated
with granting discounts or waiving sur-
charges for all participants who qualify
for an alternative, estimated here at $1
million to $5 million, or about $55 to
$221 per affected plan. Plans have the
flexibility to transfer some or all of this
cost evenly to all participants in the form
of small premium increases or benefit
cuts.

The fourth requirement provides that
plan materials describing wellness plan
standards must disclose the availability of
reasonable alternative standards. This
requirement will affect the 36,000 small
plans that apply discounts or surcharges.
These plans will incur economic costs to
revise affected plan materials. The 5,000
to 18,000 small plan participants who will
succeed at satisfying these alternative
standards will benefit from these disclo-
sures. The disclosures need not specify
what alternatives are available, and the
regulation provides model language that
can be used to satisfy this requirement.
Legal requirements other than this regula-
tion generally require plans and issuers to
maintain accurate materials describing
plans. Plans and issuers generally update
such materials on a regular basis as part of

their normal business practices. This
requirement is expected to represent a
negligible fraction of the ongoing, normal
cost of updating plans' materials. This
analysis therefore attributes no cost to this
requirement.

## Special Analyses - Department of the Treasury

It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a reg-
ulatory assessment is not required. It also
has been determined that this notice of
proposed rulemaking does not impose a
collection of information on small entities
and is not subject to section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5). For these reasons, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply pursuant to 5
U.S.C. section 603(a), which exempts
from the Act's requirements certain rules
involving the internal revenue laws.
Pursuant to section 7805(f) of the Internal
Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.

## Paperwork Reduction Act

Department of Labor and Department of
the Treasury

This Notice of Proposed Rulemaking
includes a requirement that if the plan mate-
rials describe the standard required to be met
in order to qualify for a reward such as a pre-
mium discount or waiver of a cost-sharing
requirement, they must also disclose the
availability of a reasonable alternative stan-
dard. However, plan materials are not
required to describe specific reasonable
alternatives. The proposal also includes
examples of disclosures which would satisfy
the requirements of the proposed rule.

Plan administrators of group health
plans covered under Title I of ERISA are
required to make certain disclosures about
the terms of a plan and material changes
in terms through a Summary Plan
Description or Summary of Material
Modifications pursuant to sections 101(a)
and 102(a) of ERISA. Group health plans
and issuers also typically make other

informational materials available to par-
ticipants, either as a result of state and
local requirements, or as part of their
usual business practices in connection
with the offer and promotion of health
care coverage to employees.

While this proposal may cause group
health plans to modify informational
materials pertaining to wellness pro-
grams, the Departments conclude that it
creates no new information collection
requirements, and that the overall impact
on existing information collection activi-
ties will be negligible. First, as described
earlier, it is estimated that the proposed
reasonable alternative requirements for
bona fide wellness programs will impact a
maximum of 22,000 plans and 229,000
participants. These numbers are very
small in comparison with the 2.5 million
ERISA group health plans that cover 65
million participants, and 175,500 state
and local governmental plans that cover
11.5 million participants.

In addition, because model language is
provided in the proposal, these modifica-
tions are expected to require a minimal
amount of effort, such that they fall within
the provision of OMB regulations in 5 CFR
1320.3(c)(2). This provision excludes from
the definition of collection of information
language which is supplied by the Federal
government for disclosure purposes.

Finally, the Department of Labor's
methodology in accounting for the burden
of the Summary Plan Description (SPD)
and Summary of Material Modifications
(SMM), as currently approved under
OMB control number 1210-0039, incor-
porates an assumption concerning a con-
stant rate of revision in these disclosure
materials which is based on plans' actual
reporting on the annual report/return
(Form 5500) of their rates of modifica-
tion. This occurrence of SPD revisions is
generally more frequent than the mini-
mum time frames described in section
104(b) and related regulations. The annu-
al hour and cost burdens of the SMM/SPD
information collection request is currently
estimated at 576,000 hours and $97 mil-
lion. Because the burden of modifying a
wellness program's disclosures is expect-
ed to be negligible, and readily incorpo-
rated in other revisions made to plan
materials on an ongoing basis, the
methodology used already accounts for
this type of change. Therefore, the

Department concludes that the modifica-
tion described in this proposal to the
information collection request is neither
substantive nor material, and accordingly
it attributes no burden to this regulation.

### Department of Health and Human Services

Under the Paperwork Reduction Act of
1995, we are required to provide 60-day
notice in the Federal Register and solicit
public comment before a collection of
information requirement is submitted to
the Office of Management and Budget
(OMB) for review and approval. In order
to fairly evaluate whether an information
collection should be approved by OMB,
section 3506(c)(2)(A) of the Paperwork
Reduction Act of 1995 requires that we
solicit comment on the following issues:

· The need for the information collection
and its usefulness in carrying out the
proper functions of our agency.

· The accuracy of our estimate of the
information collection burden.

· The quality, utility, and clarity of the
information to be collected.

· Recommendations to minimize the
information collection burden on the
affected public, including automated
collection techniques.

Section 146.121 Prohibiting
discrimination against participants and
beneficiaries based on a health factor.

(f) Bona fide wellness programs
Paragraph (1)(iv) requires the plan or
issuer to disclose in all plan materials
describing the terms of the program the
availability of a reasonable alternative
standard required under paragraph
(f)(1)(iii) of this section. However, in
plan materials that merely mention that a
program is available, without describing
its terms, the disclosure is not required.
This requirement will affect the estimated
1,300 nonfederal governmental plans that
apply premium discounts or surcharges.
The development of the materials is
expected to take 100 hours for nonfederal
governmental plans. The corresponding
burden performed by service providers is
estimated to be $38,000.

We have submitted a copy of this rule
to OMB for its review of the information
collection requirements. These require-
ments are not effective until they have

been approved by OMB. A notice will be
published in the Federal Register when
approval is obtained.

If you comment on any of these infor-
mation collection and record keeping
requirements, please mail copies directly
to the following:

Health Care Financing Administration,
Office of Information Services,
Information Technology Investment
Management Group,
Division of HCFA Enterprise Standards,
Room C2-26-17, 7500 Security Boule-
vard,
Baltimore, MD 21244-1850,
Attn: John Burke, HCFA-2078-P,
and
Office of Information and Regulatory
Affairs,
Office of Management and Budget,
Room 10235, New Executive Office
Building,
Washington, DC 20503,
Attn .: Allison Herron Eydt, HCFA-
2078-P.

## Small Business Regulatory Enforcement Fairness Act

The proposed rule is subject to the provi-
sions of the Small Business Regulatory
Enforcement Fairness Act of 1996 (5 U.S.C.
801 et seq.) and, if finalized, will be trans-
mitted to Congress and the Comptroller
General for review. The rule is not a "major
rule" as that term is defined in 5 U.S.C. 804,
because it is not likely to result in (1) an
annual effect on the economy of $100 mil-
lion or more; (2) a major increase in costs or
prices for consumers, individual industries,
or federal, State, or local government agen-
cies, or geographic regions; or (3) significant
adverse effects on competition, employment,
investment, productivity, innovation, or on
the ability of United States-based enterprises
to compete with foreign-based enterprises in
domestic or export markets.

## Unfunded Mandates Reform Act

For purposes of the Unfunded Mandates
Reform Act of 1995 (Public Law 104-4),
as well as Executive Order 12875, this pro-
posed rule does not include any Federal
mandate that may result in expenditures by
State, local, or tribal governments, nor
does it include mandates which may
impose an annual burden of $100 million
or more on the private sector.

## Federalism Statement - Department of Labor and Department of Health and Human Services

In the Departments' view, these proposed
regulations do not have federalism implica-
tions, because they do not have substantial
direct effects on the States, the relationship
between the national government and
States, or on the distribution of power and
responsibilities among various levels of
government. This is largely because, with
respect to health insurance issuers, the vast
majority of States have enacted laws which
meet or exceed the federal standards in
HIPAA prohibiting discrimination based on
health factors. Therefore, the regulations
are not likely to require substantial addi-
tional oversight of States by the Department
of Health and Human Services.

In enacting these new preemption pro-
visions, Congress indicated its intent to
establish a preemption of State insurance

requirements only to the extent that those
requirements prevent the application of
the basic protections set forth in HIPAA.
HIPAA's Conference Report states that
the conferees intended the narrowest pre-
emption of State laws with regard to
health insurance issuers. H.R. Conf. Rep.
No. 736, 104th Cong. 2d Session 205
(1996). Consequently, under the statute
and the Conference Report, State insur-
ance laws that are more stringent than the
federal requirements are unlikely to "pre-
vent the application of" the HIPAA
nondiscrimination provisions.

Accordingly, States are given signifi-
cant latitude to impose requirements on
health insurance issuers that are more
restrictive than the federal law. In many
cases, the federal law imposes minimum
requirements which States are free to
exceed. Guidance conveying this inter-
pretation was published in the Federal
Register on April 8, 1997, and these reg-
ulations do not reduce the discretion given
to the States by the statute. It is the
Departments' understanding that the vast
majority of States have in fact implement-
ed provisions which meet or exceed the
minimum requirements of the HIPAA
non-discrimination provisions.

HIPAA provides that the States may
enforce the provisions of HIPAA as they
pertain to issuers, but that the Secretary of
Health and Human Services must enforce
any provisions that a State fails to sub-
stantially enforce. When exercising its
responsibility to enforce the provisions of
HIPAA, HCFA works cooperatively with
the States for the purpose of addressing
State concerns and avoiding conflicts with
the exercise of State authority.2 HCFA
has developed procedures to implement
its enforcement responsibilities, and to
afford the States the maximum opportuni-
ty to enforce HIPAA's requirements in the
first instance. HCFA's procedures address

2 This authority applies to insurance issued with
respect to group health plans generally, including
plans covering employees of church organizations.
Thus, this discussion of federalism applies to all
group health insurance coverage that is subject to the
PHS Act, including those church plans that provide
coverage through a health insurance issuer (but not
to church plans that do not provide coverage through
a health insurance issuer). For additional informa-
tion relating to the application of these nondiscrimi-
nation rules to church plans, see the preamble to reg-
ulations being proposed elsewhere in this issue of
the Bulletin regarding section 9802(c) of the Code
relating to church plans.

the handling of reports that States may not
be enforcing HIPAA's requirements, and
the mechanism for allocating enforcement
responsibility between the States and
HCFA. To date, HCFA has had occasion
to enforce the HIPAA non-discrimination
provisions in only two States.

Although the Departments conclude
that these proposed regulations do not
have federalism implications, in keeping
with the spirit of the Executive Order that
agencies closely examine any policies that
may have federalism implications or limit
the policy making discretion of the States,
the Department of Labor and HCFA have
engaged in numerous efforts to consult
with and work cooperatively with affected
State and local officials.

For example, the Departments were
aware that some States commented on the
way the federal provisions should be inter-
preted. Therefore, the Departments have
sought and received input from State insur-
ance regulators and the National
Association of Insurance Commissioners
(NAIC). The NAIC is a non-profit corpo-
ration established by the insurance com-
missioners of the 50 States, the District of
Columbia, and the four U.S. territories, that
among other things provides a forum for
the development of uniform policy when
uniformity is appropriate. Its members
meet, discuss, and offer solutions to mutu-
al problems. The NAIC sponsors quarterly
meetings to provide a forum for the
exchange of ideas, and in-depth considera-
tion of insurance issues by regulators,
industry representatives, and consumers.
HCFA and Department of Labor staff have
attended the quarterly meetings consistent-
ly to listen to the concerns of the State
Insurance Departments regarding HIPAA
issues, including the nondiscrimination
provisions. In addition to the general dis-
cussions, committee meetings and task
groups, the NAIC sponsors the following
two standing HIPAA meetings for mem-
bers during the quarterly conferences:

· HCFA/DOL Meeting on HIPAA
Issues (This meeting provides
HCFA and Labor the opportunity
to provide updates on regulations,
bulletins, enforcement actions and
outreach efforts regarding
HIPAA.)

· The NAIC/HCFA Liaison Meeting
(This meeting provides HCFA and
the NAIC the opportunity to dis-

cuss HIPAA and other health care
programs.)

In their comments on the 1997 interim
rules, the NAIC suggested that the permis-
sible standards for determining bona fide
wellness programs ensure that such pro-
grams are not used as a proxy for discrimi-
nation based on a health factor. The NAIC
also commented that the nondiscrimination
provisions of HIPAA "are especially signif-
icant in their impact on small groups, and
particularly in small groups, where there is
a great potential for adverse selection and
gaming." One State asked that the
Departments' final nondiscrimination pro-
visions be as consumer-protective as possi-
ble. Finally, another State described
already-existing State regulation of issuers
offering wellness programs in that State and
asked that standards for bona fide wellness
programs be left to the States.

The Departments considered these views
very carefully when formulating the well-
ness program proposal. While allowing
plans a great deal of flexibility in determin-
ing what kinds of incentives best encourage
the plan's own participants and beneficiaries
to pursue a healthier lifestyle, the
Departments proposal ensures that individu-
als have an opportunity to qualify for the pre-
mium discount or other reward. If an indi-
vidual is unable to satisfy a wellness
program standard due to a health factor,
plans are required to make a reasonable alter-
native standard available to the individual.
In addition, the Departments reiterate their
position that State insurance laws that are
more stringent than the federal requirements
are unlikely to "prevent the application of"
the federal law and therefore are saved from
preemption. Therefore, these more protec-
tive State laws continue to apply for individ-
uals receiving health insurance coverage in
connection with a group health plan.

The Departments welcome further
comment on these issues from the States
in response to this proposal.

with the States - the Consumer Outreach
and Advocacy conferences in March 1999
and June 2000, the Implementation and
Enforcement of HIPAA National State-
Federal Conferences in August 1999 and
2000. Furthermore, both the Department
of Labor and HCFA websites offer links to
important State websites and other
resources, facilitating coordination
between the State and federal regulators
and the regulated community.

In conclusion, throughout the process of
developing these regulations, to the extent
feasible within the specific preemption pro-
visions of HIPAA, the Departments have
attempted to balance the States' interests in
regulating health plans and health insurance
issuers, and the rights of those individuals
that Congress intended to protect through
the enactment of HIPAA.

## Unified Analysis of Costs and Benefits - Department of Labor and Department of Health and Human Services

### Introduction

Under the proposed regulation, health
plans generally may vary employee pre-
mium contributions or benefit levels
across similarly situated individuals based
on health factors only in connection with
bona fide wellness programs. The regula-
tion establishes four requirements for
such bona fide wellness programs.

A large body of literature, together with
comments received by the Departments,
demonstrate that well-designed wellness
programs can deliver benefits well in
excess of their costs. For example, the
U.S. Centers for Disease Control and
Prevention estimate that implementing
proven clinical smoking cessation inter-
ventions can save one year of life for each
$2,587 invested. In addition to reduced
mortality, benefits of effective wellness
programs can include reduced absen-
teeism, improved productivity, and
reduced medical costs. The requirements
contained in the proposed regulation were
crafted to accommodate and not impair
such beneficial programs, while combat-
ing discrimination in eligibility and pre-
miums for similarly situated individuals
as intended by Congress.

### Detailed Estimates

Estimation of the economic impacts of
the four requirements is difficult because

data on affected plans' current practices
are incomplete, and because plans'
approaches to compliance with the
requirements and the effects of those
approaches will vary and cannot be pre-
dicted. Nonetheless, the Departments
undertook to consider the impacts fully
and to develop estimates based on reason-
able assumptions.

Based on a 1993 survey of employers
by the Robert Wood Johnson Foundation,
the Departments estimate that 1.6 percent
of large plans and 1.2 percent of small
plans currently vary employee premium
contributions across similarly situated
individuals and will be subject to the four
requirements for bona fide wellness pro-
grams. This amounts to 32,000 plans cov-
ering 1.2 million participants. According
to an industry survey by Hewitt
Associates, just more than one-third as
many plans vary benefit levels across sim-
ilarly situated individuals as vary premi-
ums. This amounts to 11,000 plans cov-
ering 415,000 participants. The
Departments separately considered the
effect of each of the four requirements on
these plans. For purposes of its estimates,

the Departments assumed that one-half of
the plans in the latter group are also
included in the former, thereby estimating
that 37,000 plans covering 1.4 million
participants will be subject to the four
requirements for bona fide wellness pro-
grams.

Limit on Dollar Amount - Under the
first requirement, any discount or sur-
charge, whether applicable to employee
premiums or benefit levels, must not
exceed a specified percentage of the total
premium for employee-only coverage
under the plan. The proposed regulations
specify three alternative percentages: 10,
15, and 20. For purposes of this discus-
sion, the Departments examine the mid-
point of the three alternative percentages,
15 percent.

The Departments lack representative
data on the magnitude of the discounts
and surcharges applied by affected plans
today. One leading consultant practicing
in this area believes that wellness incen-
tive premium discounts ranged from
about $60 to about $480 annually in
1998, averaging about $240 that year.
Expressed as a percentage of average

total premium for employee-only cover-
age that year, this amounts to a range of
about 3 percent to 23 percent and an aver-
age of about 11 percent. This suggests
that most affected plans, including some
whose discounts are somewhat larger
than average, already comply with the
first requirement and will not need to
reduce the size of the discounts or sur-
charges they apply. It appears likely,
however, that a sizeable minority of plans
\- perhaps a few thousand plans covering
a few hundred thousand participants -
will need to reduce the size of their dis-
counts or surcharges in order to comply
with the first requirement. The table
below summarizes the Departments'
assumptions regarding the size of dis-
counts and surcharges at year 2000 lev-
els, expressed in annual amounts.

The Departments considered the poten-
tial economic effects of requiring these
plans to reduce the size of their discounts
or surcharges. These effects are likely to
include transfers of costs among plan
sponsors and participants, as well as new
economic costs and benefits.

Single employee total premium

$2,448

Discount or Surcharge

low

$70

average

11%

$280

high

23%

$560

Cap on discount or surcharge

15%

$367

Transfers will arise as plans reduce
discounts and surcharges. Plan sponsors
can exercise substantial control over the
size and direction of these transfers.
Limiting the size of discounts and sur-
charges restricts only the differential
treatment of participants who satisfy
wellness program standards and those
who do not. It does not, for example,
restrict plans sponsors' flexibility to
determine the respective employer and
employee shares of base premiums.
Possible outcomes include a transfer of
costs to plan sponsors from participants
who satisfy wellness program standards,
from plan sponsors to participants who
do not satisfy the standards, from partic-
ipants who satisfy the standards to those

who do not, or some combination of
these.

The Departments developed a very
rough estimate of the total amount of
transfers that might derive from this
requirement. The Departments' estimate
assumes that (1) all discounts and sur-
charges take the form of employee premi-
um discounts; (2) discounts are distrib-
uted evenly within both the
low-to-average range and the average-to-
high range, and are distributed across
these ranges such that their mean equals
the assumed average; and (3) 70 percent
of participants qualify for the discount.
This implies that just more than one-
fourth of plans with discounts or sur-
charges will be impacted by the cap, and

that these plans' current discounts and
surcharges exceed the cap by $86 on aver-
age. The 9,600 affected plans could satis-
fy this requirement by reducing premiums
for the 106,000 participants who do not
qualify by $86 annually, for an aggregate,
ongoing annual transfer of approximately
$9 million. The Departments solicit com-
ments on their assumptions and estimate,
and would welcome information support-
ive of better estimates.

New economic costs and benefits may
arise if changes in the size of discounts or
surcharges result in changes in participant
behavior.

Net economic welfare might be lost if
some wellness programs' effectiveness is
eroded, but the magnitude and incidence

of such effects is expected to be negligi-
ble. Consider a wellness program that
discounts premiums for participants who
take part in an exercise program. It is
plausible that, at the margin, a few partic-
ipants who would take part in order to
obtain a discount of between $368 and
$560 annually will not take part to obtain
a discount of $367. This might represent
a net loss of economic welfare. This
effect is expected to be negligible, howev-
er. Based on the assumptions specified
above, just 248,000 participants now
qualifying for discounts would be affect-
ed. Reductions in discounts are likely to
average about $86 annually, which
amounts to $7 per month or $3 per
biweekly pay period. Employee premi-
ums are often deducted from pay pre-tax,
so the after tax value of these discounts
may be even smaller. Moreover, the pro-
posed regulation caps only discounts and
surcharges applied to similarly situated
individuals in the context of a group
health plans. It does not restrict plan
sponsors from employing other motiva-
tional tools to encourage participation in
wellness programs. According to the
Hewitt survey, among 408 employers that
offered incentives for participation in
wellness programs, 24 percent offered
awards or gifts and 62 percent varied life
insurance premiums, while just 14 percent
varied medical premiums.

On the other hand, net economic wel-
fare likely will be gained in instances
where large premium differentials would
otherwise have served to discourage
enrollment in health plans by employees
who did not satisfy wellness program
requirements. Consider a plan that pro-
vides a very large discount for non-smok-
ers. The very high employee premiums
charged to smokers might discourage
some from enrolling in the plan at all, and
some of these might be uninsured as a
result. It seems unlikely that the plan
sponsor would respond to the first
requirement of the proposed regulation by
raising premiums drastically for all non-
smokers, driving many out of the plan.
Instead, the plan sponsor would reduce
premiums for smokers, and more smokers
would enroll. This would result in trans-
fers to newly enrolled smokers from the
plan sponsor (and possibly from non-
smokers if the plan sponsor makes other
changes to compensation). But it would

also result in net gains in economic wel-
fare from reduced uninsurance.

The Departments believe that the net
economic gains from prohibiting dis-
counts and surcharges so large that they
could discourage enrollment based on
health factors outweigh any net losses that
might derive from the negligible reduc-
tion of some employees' incentive to par-
ticipate in wellness programs. Comments
are solicited on the magnitude of these
and any other effects and on the attendant
costs and benefits.

Reasonable Design - Under the sec-
ond requirement, the program must be
reasonably designed to promote health or
prevent disease. The Departments believe
that a program that is not so designed
would not provide economic benefits, but
would serve merely to transfer costs from
plan sponsors to targeted individuals
based on health factors. This requirement
therefore is not expected to impose eco-
nomic costs but might prompt transfers of
costs from otherwise targeted individuals
to their plans' sponsors (or to other partic-
ipants in their plans if plan sponsors elect
to pass these costs back evenly to all par-
ticipants). Comments received by the
Departments and available literature on
employee wellness programs, however,
suggest that existing wellness programs
generally satisfy this requirement. The
requirement therefore is not expected to
compel plans to modify existing wellness
programs. It is not expected to entail eco-
nomic costs nor to prompt transfers. The
Departments would appreciate comments
on this conclusion and information on the
types of existing wellness programs (if
any) that would not satisfy requirement.

Uniform Availability - The third
requirement provides that rewards under
the program must be available to all simi-
larly situated individuals. In particular,
the program must allow any individual for
whom it would be unreasonably difficult
due to a medical condition to satisfy the
initial program standard an opportunity to
satisfy a reasonable alternative standard.
Comments received by the Departments
and available literature on employee well-
ness programs suggest that some wellness
programs do not currently satisfy this
requirement and will have to be modified.
Based on the Hewitt survey, the
Departments estimate that among
employers that provide incentives for

employees to participate in wellness pro-
grams, 18 percent require employees to
achieve a low risk behavior to qualify for
the incentive, 79 percent require a pledge
of compliance, and 38 percent require par-
ticipation in a program. (These numbers
sum to more than 100 percent because
wellness programs may apply more than
one criterion.) Depending on the nature
of the wellness program, it might be
unreasonably difficult due to a medical
condition for at least some plan partici-
pants to achieve the behavior or to comply
with or participate in the program.

The Departments identified three broad
types of economic impact that might arise
from the third requirement. First, affected
plans will incur some economic cost to
make available reasonable alternative
standards. Second, additional economic
costs and benefits may arise depending on
the nature of alternatives provided, indi-
viduals' use of these alternatives, and any
changes in the affected individuals'
behavioral and health outcomes. Third,
some costs may be transferred from indi-
viduals who would fail to satisfy pro-
grams' initial standards, but who will sat-
isfy reasonable alternative standards once
available (and thereby qualify for associ-
ated discounts), to plan sponsors (or to
other participants in their plans if plan
sponsors elect to pass these costs back
evenly to all participants).

The Departments note that some plans
that apply different discounts or sur-
charges to similarly situated individuals
and are therefore subject to the require-
ment may not need to provide alternative
standards. The requirement provides that
alternative standards need not be specified
or provided until a participant for whom it
is unreasonably difficult due to a medical
condition to satisfy the initial standard
seeks such an alternative. Some wellness
programs' initial standards may be such
that no participant would ever find them
unreasonably difficult to satisfy due to a
medical condition. The Departments
reviewed Hewitt survey data on wellness
program standards and criteria. Based on
their review they estimate that 20,000 of
the 35,000 potentially affected plans have
initial wellness program standards that
might be unreasonably difficult for some
participants to satisfy due to a medical
condition. Moreover, because alterna-
tives need not be made available until

they are sought by qualified plan partici-
pants, it might be possible for some of
these plans to go for years or even indefi-
nitely without needing to make available
an alternative standard. This could be
particularly likely for small plans. The
most common standards for wellness pro-
grams pertain to smoking, blood pressure,
and cholesterol levels, according to the
Hewitt Survey. Based on U.S. Centers for
Disease Control and Management data on
the incidence of certain health habits and
conditions in the general population, the
Departments estimate that among compa-
nies with 5 employees, about one-fourth
probably employ no smokers, and about
one-third probably employ no one with
high blood pressure or cholesterol.
Approximately 96 percent of all plans
with potentially difficult initial wellness
program standards have fewer than 100
participants.

How many participants might qualify
for, seek, and ultimately satisfy alternative
standards? The Departments lack suffi-
cient data to estimate these counts with
confidence. Rough estimates were devel-
oped as follows. The Departments exam-
ined the Hewitt survey of wellness pro-
gram provisions and U.S. Centers for
Disease Control and Prevention statistics
on the incidence of certain health habits
and conditions in the general population
in order to discern how wellness pro-
grams' initial standards might interact
with plan participants' health habits and
health status. Based on these data, it
appears that as many as 29 percent of par-
ticipants in plans with discounts or sur-
charges, or 394,000 individuals, might fail
to satisfy wellness programs' initial stan-
dards. Of these, approximately 229,000
are in the 22,000 plans which apply stan-
dards that might be unreasonably difficult
due to a medical condition for some plan
participants to satisfy, the Departments
estimate. The standards would in fact be
unreasonably difficult to satisfy for some
subset of these individuals - 148,000 by
the Departments' estimate. The
Departments lack any basis to estimate
how many of these will avail themselves
of an alternative standard, or how many
that do will succeed in satisfying that
standard. To estimate the potential impact
of this requirement, the Departments con-
sidered two assumptions: an upper bound

assumption under which all 148,000 indi-
viduals seek and satisfy alternative stan-
dards, and an alternative assumption
under which one-half (or 74,000) seek an
alternative and one-half of those (37,000)
satisfy it.

Where plans are required to make
available reasonable alternative standards,
what direct costs will they incur? The
regulation does not prescribe a particular
type of alternative standard that must be
provided. Instead, it permits plan spon-
sors flexibility to provide any reasonable
alternative. The Departments expect that
plans sponsors will select alternatives that
entail the minimum net costs (or, stated
differently, the maximum net benefits)
that are possible. Plan sponsors may
select low-cost alternatives, such as
requiring an individual for whom it would
be unreasonably difficult to quit smoking
(and thereby qualify for a non-smoker dis-
count) to attend a smoking cessation pro-
gram that is available at little or no cost in
the community, or to watch educational
videos or review educational literature.
Plan sponsors presumably will select
higher-cost alternatives only if they there-
by derive offsetting benefits, such as a
higher smoking cessation success rate.
The Departments also note that the num-
ber of plans with initial wellness program
standards that might be unreasonably dif-
ficult for some participants to satisfy is
probably small (having been estimated at
22,000, or 1 percent of all plans), as is the
number of individuals who would take
advantage of alternative standards (esti-
mated at between 74,000 and 148,00, or
between 0.1 percent and 0.2 percent of all
participants).

It seems reasonable to presume that the
net cost plan sponsors will incur in the
provision of alternatives, including trans-
fers as well as new economic costs and
benefits, will not exceed the transfer cost
of providing discounts (or waiving sur-
charges) for all plan participants who
qualify for alternatives, which is estimat-
ed below at between $9 million and $37
million. It is likely that many plan spon-
sors will find more cost effective ways to
satisfy this requirement, and that the true
net cost to them will therefore be much
smaller than this. The Departments have
no basis for estimating the magnitude of
the cost of providing alternative standards

or of potential offsetting benefits, howev-
er, and therefore solicit comments from
the public on this question.

What other economic costs and benefits
might arise where alternative standards
are made available? A large number of
outcomes are possible. Consider a pro-
gram that provides premium discounts for
non-smokers.

It is possible that some individuals who
would have quit smoking in order to qual-
ify for a discount will nonetheless find it
unreasonably difficult to quit and will
obtain the discount while continuing to
smoke by satisfying an alternative stan-
dard. This would represent a net loss of
economic welfare from increased smok-
ing.

On the other hand, consider individuals
who, in the context of the initial program,
are unable or unwilling to quit smoking.
It seems likely that some of these individ-
uals could quit with appropriate assis-
tance, and that some alternative standards
provided by plan sponsors will provide
such assistance. In such cases, a program
which had the effect of shifting premium
costs to smokers would be transformed
into one that successfully reduced smok-
ing. This would represent a net gain of
economic welfare.

Which scenario is more likely? The
Departments have no concrete basis for
answering this question, and therefore
solicit comments on it. However, the
Departments note that plan sponsors will
have strong motivation to identify and
provide alternative standards that have
positive net economic effects. They will
be disinclined to provide alternatives that
undermine their overall wellness program
and worsen behavioral and health out-
comes, or that make financial rewards
available absent meaningful efforts by
participants to improve their health habits
and health. Instead they will be inclined
to provide alternatives that sustain or rein-
force plan participants' incentive to
improve their health habits and health,
and/or that help participants make such
improvements. It therefore seems likely
that gains in economic welfare from this
requirement will equal or outweigh loss-
es. The Departments anticipate that the
requirement to provide reasonable alter-
native standards will reduce instances
where wellness programs serve only to

shift costs to higher risk individuals and
increase instances where programs suc-
ceed at helping high risk individuals
improve their health habits and health.

What transfers of costs might derive
from the availability of (and participants'
satisfaction of) alternative standards? The
transfers arising from this requirement
may take the form of transfers to partici-
pants who satisfy new alternative well-
ness program standards from plan spon-
sors, to such participants from other
participants, or some combination of
these. The Departments estimated poten-
tial transfers as follows. Assuming aver-
age annual total premiums for employee-
only coverage of $2,448,3 the maximum
allowable discount of 15 percent amounts
to $367 per year. As noted earlier, dis-
counts under existing wellness programs
appear to average about 11 percent (or
$280 per year for a plan costing $2,448),
ranging from 3 percent ($70) to 23 per-
cent ($560). Reducing all discounts
greater than $367 per year to that amount
will reduce the average, perhaps to about
$251. Assuming that the 37,000 to
148,000 participants who satisfy alterna-
tive standards would not have satisfied the
wellness programs' initial standards, the
transfers attributable to their discounts
and hence to this requirement would
amount to between $9 million and $37
million. The Departments solicit com-
ments on their assumptions and estimates
regarding transfers that may derive from
this requirement.

Disclosure of Alternatives' Availability
\- The fourth requirement provides that
plan materials describing wellness plan
standards must disclose the availability of
reasonable alternative standards. This
requirement will affect the 37,000 plans
that apply discounts or surcharges. These
plans will incur economic costs to revise
affected plan materials. The 37,000 to
148,000 participants who will succeed at
satisfying these alternative standards will
benefit from these disclosures. The dis-
closures need not specify what alterna-
tives are available, and the regulation pro-
vides model language that can be used to
satisfy this requirement. The

3Average level based on the Kaiser Family
Foundation/Health Research and Education Trust
Survey of Employer-Sponsored Health benefits,
1999, projected by the Departments to 2000 levels.

Departments generally account elsewhere
for plans' cost of updating such materials
to reflect changes in plan provisions as
required under various disclosure require-
ments and as is part of usual business
practice. This particular requirement is
expected to represent a negligible fraction
of the ongoing cost of updating plans'
materials, and is not separately accounted
for here.

* * * * *

## Proposed Amendments to the Regulations

Accordingly, 26 CFR part 54 is pro-
posed to be amended as follows:

PART 54 - PENSION EXCISE TAXES

Paragraph 1. The authority citation for
part 54 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 54.9802-1 is amended
by adding text to paragraph (f) to read as
follows:

§54.9802-1 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

* * * * *

(f) Bona fide wellness programs - (1)
Definition. A wellness program is a bona
fide wellness program if it satisfies the
requirements of paragraphs (f)(1)(i)
through (f)(1)(iv) of this section.
However, a wellness program providing a
reward that is not contingent on satisfying
a standard related to a health factor does
not violate this section even if it does not
satisfy the requirements of this paragraph
(f) for a bona fide wellness program.

(i) The reward for the wellness pro-
gram, coupled with the reward for other
wellness programs with respect to the
plan that require satisfaction of a standard
related to a health factor, must not exceed
[10/15/20] percent of the cost of employ-
ee-only coverage under the plan. For this
purpose, the cost of employee-only cover-
age is determined based on the total
amount of employer and employee contri-
butions for the benefit package under
which the employee is receiving cover-
age. A reward can be in the form of a dis-
count, a rebate of a premium or contribu-
tion, or a waiver of all or part of a
cost-sharing mechanism (such as

deductibles, copayments, or coinsurance),
or the absence of a surcharge.

(ii) The program must be reasonably
designed to promote good health or pre-
vent disease. For this purpose, a program
is not reasonably designed to promote
good health or prevent disease unless the
program gives individuals eligible for the
program the opportunity to qualify for the
reward under the program at least once
per year.

(iii) The reward under the program
must be available to all similarly situated
individuals. A reward is not available to
all similarly situated individuals for a
period unless the program allows -

(A) A reasonable alternative standard
to obtain the reward to any individual for
whom, for that period, it is unreasonably
difficult due to a medical condition to sat-
isfy the otherwise applicable standard for
the reward; and

(B) A reasonable alternative standard
to obtain the reward to any individual for
whom, for that period, it is medically
inadvisable to attempt to satisfy the other-
wise applicable standard for the reward.

(iv) The plan must disclose in all plan
materials describing the terms of the pro-
gram the availability of a reasonable alter-
native standard required under paragraph
(f)(1)(iii) of this section. (However, in
plan materials that merely mention that a
program is available, without describing
its terms, this disclosure is not required.)
The following language, or substantially
similar language, can be used to satisfy
this requirement: "If it is unreasonably
difficult due to a medical condition for
you to achieve the standards for the
reward under this program, or if it is med-
ically inadvisable for you to attempt to
achieve the standards for the reward under
this program, call us at [insert telephone
number] and we will work with you to
develop another way to qualify for the
reward." In addition, other examples of
language that would satisfy this require-
ment are set forth in Examples 4, 5, and 6
of paragraph (f)(2) of this section.

(2) Examples. The rules of this para-
graph (f) are illustrated by the following
examples:

Example 1. (i) Facts. A group health plan offers
a wellness program to participants and beneficiaries
under which the plan provides memberships to a
local fitness center at a discount.

(ii) Conclusion. In this Example 1, the reward
under the program is not contingent on satisfying

any standard that is related to a health factor.
Therefore, there is no discrimination based on a
health factor under either paragraph (b) or (c) of this
section and the requirements for a bona fide wellness
program do not apply.

Example 2. (i) Facts. An employer sponsors a
group health plan. The annual premium for employ-
ee-only coverage is $2,400 (of which the employer
pays $1,800 per year and the employee pays $600
per year). The plan implements a wellness program
that offers a $240 rebate on premiums to program
enrollees.

(ii) Conclusion. In this Example 2, the program
satisfies the requirements of paragraph (f)(1)(i) of
this section because the reward for the wellness pro-
gram, $240, does not exceed [10/15/20] percent of
the total annual cost of employee-only coverage,
[$240/$360/$480]. ($2,400 x [10/15/20]% =
[$240/$360/$480].)

Example 3. (i) Facts. A group health plan gives
an annual premium discount of [10/15/20] percent of
the cost of employee-only coverage to participants
who adhere to a wellness program. The wellness
program consists solely of giving an annual choles-
terol test to participants. Those participants who
achieve a count under 200 receive the premium dis-
count for the year.

(ii) Conclusion. In this Example 3, the program
is not a bona fide wellness program. The program
fails to satisfy the requirement of being available to
all similarly situated individuals because some par-
ticipants may be unable to achieve a cholesterol
count of under 200 and the plan does not make avail-
able a reasonable alternative standard for obtaining
the premium discount. (In addition, plan materials
describing the program are required to disclose the
availability of the reasonable alternative standard for
obtaining the premium discount.) Thus, the premi-
um discount violates paragraph (c) of this section
because it may require an individual to pay a higher
premium based on a health factor of the individual
than is required of a similarly situated individual
under the plan.

Example 4. (i) Facts. Same facts as Example 3,
except that if it is unreasonably difficult due to a
medical condition for a participant to achieve the tar-
geted cholesterol count (or if it is medically inadvis-
able for a participant to attempt to achieve the tar-
geted cholesterol count), the plan will make
available a reasonable alternative standard that takes
the relevant medical condition into account. In addi-
tion, all plan materials describing the terms of the
program include the following statement: "If it is
unreasonably difficult due to a medical condition for
you to achieve a cholesterol count under 200, or if it
is medically inadvisable for you to attempt to
achieve a count under 200, call us at the number
below and we will work with you to develop anoth-
er way to get the discount." Individual D is unable
to achieve a cholesterol count under 200. The plan
accommodates D by making the discount available
to D, but only if D complies with a low-cholesterol
diet.

ly situated individuals because it accommodates
individuals for whom it is unreasonably difficult due
to a medical condition to achieve the targeted count
(or for whom it is medically inadvisable to attempt
to achieve the targeted count) in the prescribed peri-
od by providing a reasonable alternative standard.
Fourth, the plan discloses in all materials describing
the terms of the program the availability of a reason-
able alternative standard. Thus, the premium dis-
count does not violate this section.

Example 5. (i) Facts. A group health plan will
waive the $250 annual deductible (which is less than
[10/15/20] percent of the annual cost of employee-
only coverage under the plan) for the following year
for participants who have a body mass index
between 19 and 26, determined shortly before the
beginning of the year. However, any participant for
whom it is unreasonably difficult due to a medical
condition to attain this standard (and any participant
for whom it is medically inadvisable to attempt to
achieve this standard) during the plan year is given
the same discount if the participant walks for 20
minutes three days a week. Any participant for
whom it is unreasonably difficult due to a medical
condition to attain either standard (and any partici-
pant for whom it is medically inadvisable to attempt
to achieve either standard during the year) is given
the same discount if the individual satisfies a rea-
sonable alternative standard that is tailored to the
individual's situation. All plan materials describing
the terms of the wellness program include the fol-
lowing statement: "If it is unreasonably difficult due
to a medical condition for you to achieve a body
mass index between 19 and 26 (or if it is medically
inadvisable for you to attempt to achieve this body
mass index) this year, your deductible will be waived
if you walk for 20 minutes three days a week. If you
cannot follow the walking program, call us at the
number above and we will work with you to devel-
op another way to have your deductible waived, such
as a dietary regimen."

(ii) Conclusion. In this Example 5, the program
is a bona fide wellness program because it satisfies
the four requirements of this paragraph (f). First, the
program complies with the limits on rewards under a
program. Second, it is reasonably designed to pro-
mote good health or prevent disease. Third, the
reward under the program is available to all similar-
ly situated individuals because it generally accom-
modates individuals for whom it is unreasonably dif-
ficult due to a medical condition to achieve (or for
whom it is medically inadvisable to attempt to
achieve) the targeted body mass index by providing
a reasonable alternative standard (walking) and it
accommodates individuals for whom it is unreason-
ably difficult due to a medical condition (or for
whom it is medically inadvisable to attempt) to walk
by providing an alternative standard that is reason-
able for the individual. Fourth, the plan discloses in
all materials describing the terms of the program the
availability of a reasonable alternative standard for
every individual. Thus, the waiver of the deductible
does not violate this section.

However, all plan materials describing the terms of the
wellness program include the following statement: “If
it is unreasonably difficult due to a medical condition
for you to meet the requirements under this program
(or if it is medically inadvisable for you to attempt to
meet the requirements of this program), we will make
available a reasonable alternative standard for you to
avoid this surcharge." It is unreasonably difficult for
Individual E to stop smoking cigarettes due to an
addiction to nicotine (a medical condition). The plan
accommodates E by requiring E to participate in a
smoking cessation program to avoid the surcharge. E
can avoid the surcharge for as long as E participates in
the program, regardless of whether E stops smoking
(as long as E continues to be addicted to nicotine).

(ii) Conclusion. In this Example 6, the premium
surcharge is permissible as a bona fide wellness pro-
gram because it satisfies the four requirements of this
paragraph (f). First, the program complies with the
limits on rewards under a program. Second, it is rea-
sonably designed to promote good health or prevent
disease. Third, the reward under the program is avail-
able to all similarly situated individuals because it
accommodates individuals for whom it is unreason-
ably difficult due to a medical condition (or for whom
it is medically inadvisable to attempt) to quit using
tobacco products by providing a reasonable alterna-
tive standard. Fourth, the plan discloses in all materi-
als describing the terms of the program the availabili-
ty of a reasonable alternative standard. Thus, the
premium surcharge does not violate this section.
* * * * *

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.

For the reasons set forth above, 29 CFR
Part 2590 is proposed to be amended as
follows:

# PART 2590 [AMENDED] - RULES AND REGULATIONS FOR HEALTH INSURANCE PORTABILITY AND RENEWABILITY FOR GROUP HEALTH PLANS

1\. The authority citation for Part 2590
continues to read as follows:

Authority: Secs. 107, 209, 505, 701-
703, 711-713, and 731-734 of ERISA (29
U.S.C. 1027, 1059, 1135, 1171-1173,
1181-1183, and 1191-1194), as amended
by HIPAA (Public Law 104-191, 110 Stat.
1936), MHPA and NMHPA (Public Law
104-204, 110 Stat. 2935), and WHCRA
(Public Law 105-277, 112 Stat. 2681-
436), section 101(g)(4) of HIPAA, and
Secretary of Labor's Order No. 1-87, 52
FR 13139, April 21, 1987.

2\. Section 2590.702 is proposed to be
revised by adding text to paragraph (f)
to read as follows:

§ 2590.702 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

(iii) The reward under the program
must be available to all similarly situated
individuals. A reward is not available to
all similarly situated individuals for a
period unless the program allows -

(iv) The plan or issuer must disclose in
all plan materials describing the terms of
the program the availability of a reason-

able alternative standard required under
paragraph (f)(1)(iii) of this section.
(However, in plan materials that merely
mention that a program is available, with-
out describing its terms, this disclosure is
not required.) The following language, or
substantially similar language, can be
used to satisfy this requirement: "If it is
unreasonably difficult due to a medical
condition for you to achieve the standards
for the reward under this program, or if it
is medically inadvisable for you to
attempt to achieve the standards for the
reward under this program, call us at
[insert telephone number] and we will
work with you to develop another way to
qualify for the reward." In addition, other
examples of language that would satisfy
this requirement are set forth in Examples
4, 5, and 6 of paragraph (f)(2) of this sec-
tion.

(2) Examples. The rules of this para-
graph (f) are illustrated by the following
examples:

Example 1. (i) Facts. A group health plan offers
a wellness program to participants and beneficiaries
under which the plan provides memberships to a
local fitness center at a discount.

(ii) Conclusion. In this Example 1, the reward
under the program is not contingent on satisfying
any standard that is related to a health factor.
Therefore, there is no discrimination based on a
health factor under either paragraph (b) or (c) of this
section and the requirements for a bona fide wellness
program do not apply.

describing the program are required to disclose the
availability of the reasonable alternative standard for
obtaining the premium discount.) Thus, the premi-
um discount violates paragraph (c) of this section
because it may require an individual to pay a higher
premium based on a health factor of the individual
than is required of a similarly situated individual
under the plan.

(ii) Conclusion. In this Example 4, the program
is a bona fide wellness program because it satisfies
the four requirements of this paragraph (f). First, the
program complies with the limits on rewards under a
program. Second, it is reasonably designed to pro-
mote good health or prevent disease. Third, the
reward under the program is available to all similar-
ly situated individuals because it accommodates
individuals for whom it is unreasonably difficult due
to a medical condition to achieve the targeted count
(or for whom it is medically inadvisable to attempt
to achieve the targeted count) in the prescribed peri-
od by providing a reasonable alternative standard.
Fourth, the plan discloses in all materials describing
the terms of the program the availability of a reason-
able alternative standard. Thus, the premium dis-
count does not violate this section.

mass index) this year, your deductible will be
waived if you walk for 20 minutes three days a
week. If you cannot follow the walking program,
call us at the number above and we will work with
you to develop another way to have your deductible
waived, such as a dietary regimen."

(ii) Conclusion. In this Example 5, the program
is a bona fide wellness program because it satisfies
the four requirements of this paragraph (f). First,
the program complies with the limits on rewards
under a program. Second, it is reasonably designed
to promote good health or prevent disease. Third,
the reward under the program is available to all
similarly situated individuals because it generally
accommodates individuals for whom it is unrea-
sonably difficult due to a medical condition to
achieve (or for whom it is medically inadvisable to
attempt to achieve) the targeted body mass index
by providing a reasonable alternative standard
(walking) and it accommodates individuals for
whom it is unreasonably difficult due to a medical
condition (or for whom it is medically inadvisable
to attempt) to walk by providing an alternative
standard that is reasonable for the individual.
Fourth, the plan discloses in all materials describ-
ing the terms of the program the availability of a
reasonable alternative standard for every individ-
ual. Thus, the waiver of the deductible does not
violate this section.

Example 6. (i) Facts. In conjunction with an
annual open enrollment period, a group health plan
provides a form for participants to certify that they
have not used tobacco products in the preceding
twelve months. Participants who do not provide the
certification are assessed a surcharge that is
[10/15/20] percent of the cost of employee-only cov-
erage. However, all plan materials describing the
terms of the wellness program include the following
statement: "If it is unreasonably difficult due to a
health factor for you to meet the requirements under
this program (or if it is medically inadvisable for you
to attempt to meet the requirements of this program),
we will make available a reasonable alternative stan-
dard for you to avoid this surcharge." It is unrea-
sonably difficult for Individual E to stop smoking
cigarettes due to an addiction to nicotine (a medical
condition). The plan accommodates E by requiring
E to participate in a smoking cessation program to
avoid the surcharge. E can avoid the surcharge for
as long as E participates in the program, regardless
of whether E stops smoking (as long as E continues
to be addicted to nicotine).

(ii) Conclusion. In this Example 6, the premium
surcharge is permissible as a bona fide wellness pro-
gram because it satisfies the four requirements of
this paragraph (f). First, the program complies with
the limits on rewards under a program. Second, it is
reasonably designed to promote good health or pre-
vent disease. Third, the reward under the program is
available to all similarly situated individuals because
it accommodates individuals for whom it is unrea-
sonably difficult due to a medical condition (or for
whom it is medically inadvisable to attempt) to quit
using tobacco products by providing a reasonable
alternative standard. Fourth, the plan discloses in all
materials describing the terms of the program the
availability of a reasonable alternative standard.
Thus, the premium surcharge does not violate this
section.

* * * * *

Signed at Washington, DC this
28th day of December 2000.

Leslie B. Kramerich,
Assistant Secretary, Pension and Welfare
Benefits Administration,
U.S. Department of Labor.

For the reasons set forth above, we pro-
pose to amend 45 CFR Part 146 as fol-
lows:

# PART 146 [AMENDED] - RULES AND REGULATIONS FOR HEALTH INSURANCE PORTABILITY AND RENEWABILITY FOR GROUP HEALTH PLANS

1\. The authority citation for Part 146
continues to read as follows:

Authority: Secs. 2701 through 2763,
2791 and 2792 of the Public Health
Service Act, 42 U.S.C. 300gg through
300gg-63, 300gg-91, 300gg-92 as amend-
ed by HIPAA (Public Law 104-191, 110
Stat. 1936), MHPA and NMHPA (Public
Law 104-204, 110 Stat. 2935), and
WHCRA (Public Law 105-277, 112 Stat.
2681-436), and section 102(c)(4) of
HIPAA.

2\. We propose to revise § 146.121 by
adding text to paragraph (f) to read as
follows:

§ 146.121 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.

* * * * *

(f) Bona fide wellness programs - (1)
Definition. A wellness program is a bona
fide wellness program if it satisfies the
requirements of paragraphs (f)(1)(i)
through (f)(1)(iv) of this section.
However, a wellness program providing
a reward that is not contingent on satis-
fying a standard related to a health factor
does not violate this section even if it
does not satisfy the requirements of this
paragraph (f) for a bona fide wellness
program.

butions for the benefit package under
which the employee is receiving cover-
age. A reward can be in the form of a dis-
count, a rebate of a premium or contribu-
tion, or a waiver of all or part of a
cost-sharing mechanism (such as
deductibles, copayments, or coinsurance),
or the absence of a surcharge.

(ii) The program must be reasonably
designed to promote good health or prevent
disease. For this purpose, a program is not
reasonably designed to promote good health
or prevent disease unless the program gives
individuals eligible for the program the
opportunity to qualify for the reward under
the program at least once per year.

(iii) The reward under the program
must be available to all similarly situated
individuals. A reward is not available to
all similarly situated individuals for a
period unless the program allows -

(iv) The plan or issuer must disclose in
all plan materials describing the terms of
the program the availability of a reasonable
alternative standard required under para-
graph (f)(1)(iii) of this section. (However,
in plan materials that merely mention that a
program is available, without describing its
terms, this disclosure is not required.) The
following language, or substantially simi-
lar language, can be used to satisfy this
requirement: "If it is unreasonably difficult
due to a medical condition for you to
achieve the standards for the reward under
this program, or if it is medically inadvis-
able for you to attempt to achieve the stan-
dards for the reward under this program,
call us at [insert telephone number] and we
will work with you to develop another way
to qualify for the reward." In addition,
other examples of language that would sat-
isfy this requirement are set forth in
Examples 4, 5, and 6 of paragraph (f)(2) of
this section.

(2) Examples. The rules of this para-
graph (f) are illustrated by the following
examples:

Example 1. (i) Facts. A group health plan offers
a wellness program to participants and beneficiaries
under which the plan provides memberships to a
local fitness center at a discount.

(ii) Conclusion. In this Example 4, the program

is a bona fide wellness program because it satisfies
the four requirements of this paragraph (f). First, the
program complies with the limits on rewards under a
program. Second, it is reasonably designed to pro-
mote good health or prevent disease. Third, the
reward under the program is available to all similar-
ly situated individuals because it accommodates
individuals for whom it is unreasonably difficult due
to a medical condition to achieve the targeted count
(or for whom it is medically inadvisable to attempt
to achieve the targeted count) in the prescribed peri-
od by providing a reasonable alternative standard.
Fourth, the plan discloses in all materials describing
the terms of the program the availability of a reason-
able alternative standard. Thus, the premium dis-
count does not violate this section.

Example 6. (i) Facts. In conjunction with an

annual open enrollment period, a group health plan
provides a form for participants to certify that they
have not used tobacco products in the preceding
twelve months. Participants who do not provide the
certification are assessed a surcharge that is
[10/15/20] percent of the cost of employee-only cov-
erage. However, all plan materials describing the
terms of the wellness program include the following
statement: "If it is unreasonably difficult due to a
health factor for you to meet the requirements under
this program (or if it is medically inadvisable for you
to attempt to meet the requirements of this program),
we will make available a reasonable alternative stan-
dard for you to avoid this surcharge." It is unrea-
sonably difficult for Individual E to stop smoking
cigarettes due to an addiction to nicotine (a medical
condition). The plan accommodates E by requiring
E to participate in a smoking cessation program to
avoid the surcharge. E can avoid the surcharge for
as long as E participates in the program, regardless
of whether E stops smoking (as long as E continues
to be addicted to nicotine).

(ii) Conclusion. In this Example 6, the premium
surcharge is permissible as a bona fide wellness pro-
gram because it satisfies the four requirements of
this paragraph (f). First, the program complies with
the limits on rewards under a program. Second, it is
reasonably designed to promote good health or pre-
vent disease. Third, the reward under the program is
available to all similarly situated individuals because
it accommodates individuals for whom it is unrea-
sonably difficult due to a medical condition (or for
whom it is medically inadvisable to attempt) to quit
using tobacco products by providing a reasonable
alternative standard. Fourth, the plan discloses in all
materials describing the terms of the program the
availability of a reasonable alternative standard.
Thus, the premium surcharge does not violate this
section.

** * * *

Dated June 22, 2000.

Nancy-Ann Min DeParle,
Administrator, Health Care Financing
Administration.

Approved August 29, 2000.

Donna E. Shalala,
Secretary.

(Filed by the Office of the Federal Register on Janu-
ary 5, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 8, 2001, 66 F.R.
1421)

Request for Ideas for Exempt
Organizations Plain-Language
Publications and Voluntary
Compliance Programs

Announcement 2001-14

The Exempt Organizations function of
the Tax Exempt and Government Entities
Division (TE/GE) is requesting comments

in two areas directly related to its in-
creased emphasis on enhancing voluntary
compliance. As part of its reorganization,
a new Customer Education and Outreach
office has been created within Exempt
Organizations. This office will be respon-
sible for coordinating and redesigning the
means by which Exempt Organizations
interacts with its community. Exempt Or-
ganizations, as restructured, also contem-
plates the establishment of an office of
voluntary compliance.

This announcement is to request com-
ments and suggestions relating to areas
within the jurisdiction of these two new
offices. First, suggestions are being so-
licited for new initiatives in the areas of
outreach and education. In particular,
help is solicited on two items: IRS Inter-
net web-page content and plain language
publications. It is anticipated that Exempt
Organizations will develop a web page
for use in communicating with its cus-
tomers. Suggestions are solicited on how
such a web page should be designed and
what content should be included. Exempt
Organizations also intends to aggressively
pursue the issuance of plain language
publications for use by its customers. In
the past, these publications have been
successful in helping to promote compli-
ance. For example, Exempt Organiza-
tions has issued plain-language publica-
tions on various topics, including the

Gaming Publication for Tax-Exempt Or-
ganizations, Pub. 3079 (4-98), the Tax
Guide for Veterans' Organizations, Pub.
3386 (6-99), and the Draft Tax Guide For
Churches and Other Religious Organiza-
tions, Pub. 1828 (9-94). Exempt Organi-
zations plans to issue more plain-lan-
guage publications in the future as part of
its increased focus on customer education
and outreach.

Second, as its new design indicates, the
Exempt Organizations function is plan-
ning on establishing voluntary compliance
programs. It is anticipated that there may
be several programs, some of which are
very targeted (e.g., in 1992, Exempt Or-
ganizations established a voluntary com-
pliance program to resolve tax exemption
issues arising from gross or net revenue
stream joint ventures between hospitals
and their medical staffs in announcement
92-70, 1992-19 I.R.B. 89.) Other volun-
tary compliance programs may be much
broader. For example, consideration will
be given to programs to cover those orga-
nizations that came to the Internal Rev-
enue Service as non-filers or to correct
previous compliance difficulties.

Exempt Organizations invites inter-
ested members of the public to submit
written suggestions for topics for plain-
language publications, IRS Internet web-
site content, or suggestions for additional
voluntary compliance programs. Mem-

bers of the public are further invited to
submit drafts of proposed plain-language
publications or proposed voluntary com-
pliance programs if they so desire. All
submissions will be available for public
inspection and copying in their entirety.

## ADDRESS

Members of the public may submit
suggestions or drafts by electronic mes-
sage, by mail, or by hand delivery. Elec-
tronic messages may be addressed to
*TE/GE-Exempt@irs.gov. Mail may be
addressed to Ms. Virginia Richardson,
T:EO, 1111 Constitution Avenue, NW,
Washington, D.C. 20224, Attn: 2001-14.
Hand delivered items may be addressed to
Ms. Virginia Richardson, T:EO, Attn:
2001-14, and delivered, between 8:00
a.m. and 5:00 p.m., to the Courier's Desk,
1111 Constitution Avenue, NW, Washing-
ton, D.C. 20224. Exempt Organizations
regrets that it will be unable to respond in-
dividually to suggestions or drafts.

# DRAFTING INFORMATION

The principal author of this announce-
ment is Virginia Richardson of Exempt
Organizations. For further information
regarding this announcement contact Vir-
ginia Richardson at (202) 283-8938 (not a
toll-free call).

# Announcement of the Consent Voluntary Suspension of Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the Internal Revenue Service

Under 31 Code of Federal Regulations,
Part 10, an attorney, certified public ac-
countant, enrolled agent or enrolled actu-
ary, in order to avoid the institution or
conclusion of a proceeding for his disbar-
ment or suspension from practice before
the Internal Revenue Service, may offer
his consent to suspension from such prac-
tice. The Director of Practice, in his dis-
cretion, may suspend an attorney, certified
public accountant, enrolled agent or en-
rolled actuary in accordance with the con-
sent offered.

Attorneys, certified public accountants,
enrolled agents and enrolled actuaries are
prohibited in any Internal Revenue Ser-

vice matter from directly or indirectly em-
ploying, accepting assistance from, being
employed by or sharing fees with, any
practitioner disbarred or suspended from
practice before the Internal Revenue Ser-
vice.

To enable attorneys, certified public ac-
countants, enrolled agents and enrolled ac-
tuaries to identify practitioners under con-
sent suspension from practice before the
Internal Revenue Service, the Director of
Practice will announce in the Internal Rev-
enue Bulletin the names and addresses of
practitioners who have been suspended
from such practice, their designation as at-
torney, certified public accountant, en-

rolled agent or enrolled actuary, and date
or period of suspension. This announce-
ment will appear in the weekly Bulletin at
the earliest practicable date after such ac-
tion and will continue to appear in the
weekly Bulletins for five successive
weeks or for as many weeks as is practica-
ble for each attorney, certified public ac-
countant, enrolled agent or enrolled actu-
ary so suspended and will be consolidated
and published in the Cumulative Bulletin.

The following individuals have been
placed under consent suspension from
practice before the Internal Revenue Ser-
vice:

Name

Address

Designation

Date of Suspension

Sinclair, Gerald A.

Hammond, IN

Enrolled

August 16, 2000

Agent

August 15, 2001

Barrett, Norman

Dover, DE

CPA

September 1, 2000 to

November 30, 2001

Janus, Stephen E.

Michigan City, IN

CPA

September 20, 2000 to

September 19, 2003

McCormack, Frank J.

Castlebury, FL

CPA

September 20, 2000

September 19, 2003

Serio, Vinson J.

Metairie, LA

Enrolled Agent

October 1, 2000 to September 30, 2003

Baker, Linda L.

West Orange, NJ

CPA

October 20, 2000 to

April 19, 2004

Duncanson, Thomas D.

Mankato, MN

CPA

November 7, 2000 to

May 6, 2003

West, Keith

Pasadena, CA

Enrolled Agent

November 15, 2000 to

May 14, 2001

Overbeck, Marietta

Evansville, IN

CPA

November 15, 2000 to

November 14, 2002

Garrison, John L.

Guymon, OK

CPA

November 20, 2000 to

November 19, 2002

Aiken, Kim Allen

Olympia, WA

CPA

December 10, 2000

June 9, 2002

D'Arata, David J.

Buffalo, NY

CPA

January 1, 2001 to

June 30, 2003

Gambrel, Thomas R.

Corbin, KY

CPA

January 1, 2001 to

December 31, 2004

# Announcement of the Expedited Suspension of Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the Internal Revenue Service

Under title 31 of the Code of Federal
Regulations, section 10.76, the Director
of Practice is authorized to immediately
suspend from practice before the Internal
Revenue Service any practitioner who,
within five years, from the date the expe-

dited proceeding is instituted, (1) has had
a license to practice as an attorney, certi-
fied public accountant, or actuary sus-
pended or revoked for cause; or (2) has
been convicted of any crime under title 26
of the United States Code or, of a felony

under title 18 of the United States Code
involving dishonesty or breach of trust.

Attorneys, certified public accountants,
enrolled agents, and enrolled actuaries are
prohibited in any Internal Revenue Service
matter from directly or indirectly employ-

ing, accepting assistance from, being em-
ployed by, or sharing fees with, any practi-
tioner disbarred or suspended from practice
before the Internal Revenue Service.

To enable attorneys, certified pubic ac-
countants, enrolled agents, and enrolled ac-
tuaries to identify practitioners under expe-
dited suspension from practice before the
Internal Revenue Service, the Director of
Practice will announce in the Internal Rev-

enue Bulletin the names and addresses of
practitioners who have been suspended
from such practice, their designation as at-
torney, certified public accountant, enrolled
agent, or enrolled actuary, and date or pe-
riod of suspension. This announcement will
appear in the weekly Bulletin at the earliest
practicable date after such action and will
continue to appear in the weekly Bulletins
for five successive weeks or for as many

weeks as is practicable for each attorney,
certified public accountant, enrolled agent,
or enrolled actuary so suspended and will
be consolidated and published in the Cu-
mulative Bulletin.

The following individuals have been
placed under suspension from practice be-
fore the Internal Revenue Service by
virtue of the expedited proceeding provi-
sions of the applicable regulations:

Name

Address

Designation

Date of Suspension

Barger, Robert E.

Garden Ridge, TX

Attorney

Indefinite from October 10, 2000

Roberts, Thomas W.

Cincinnati OH

CPA

Indefinite from October 24, 2000

# Announcement of the Disbarment and Suspension of Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the Internal Revenue Service

Under Section 330, Title 31 of the
United States Code, the Secretary of the
Treasury, after due notice and opportunity
for hearing, is authorized to suspend or
disbar from practice before the Internal
Revenue Service any person who has vio-
lated the rules and regulations governing
the recognition of attorneys, certified
public accountants, enrolled agents or en-
rolled actuaries to practice before the In-
ternal Revenue Service.

Attorneys, certified public accountants,
enrolled agents, and enrolled actuaries are
prohibited in any Internal Revenue Service
matter from directly or indirectly employ-

ing, accepting assistance from, being em-
ployed by, or sharing fees with any practi-
tioner disbarred or under suspension from
practice before the Internal Revenue Ser-
vice.

To enable attorneys, certified public
accountants, enrolled agents and enrolled
actuaries to identify such disbarred or
suspended practitioners, the Director of
Practice will announce in the Internal
Revenue Bulletin the names and ad-
dresses of practitioners who have been
suspended from such practice, their des-
ignation as attorney, certified public ac-
countant, enrolled agent or enrolled actu-

ary, and the date of disbarment or period
of suspension. This announcement will
appear in the weekly Bulletin for five
successive weeks or as long as it is practi-
cable for each attorney, certified public
accountant, enrolled agent or enrolled ac-
tuary so suspended or disbarred and will
be consolidated and published in the Cu-
mulative Bulletin.

After due notice and opportunity for
hearing before an administrative law
judge, the following individual has been
disbarred from futher practice before the
Internal Revenue Service:

Name

Address

Designation

Effective Date

Joyner, Joseph

Gary, IN

CPA

November 24, 2000

## Definition of Terms

Revenue rulings and revenue procedures
(hereinafter referred to as "rulings")
that have an effect on previous rulings
use the following defined terms to de-
scribe the effect:

Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).

Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.

Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.

Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it ap-

## Abbreviations

The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

BK-Bank.

B.T.A .- Board of Tax Appeals.

C-Individual.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

CI-City.

COOP-Cooperative.

GP-General Partner.

Ct.D .- Court Decision.

GR-Grantor.

TFE-Transferee.

TFR-Transferor.

T.I.R .- Technical Information Release.

TP-Taxpayer.
TR-Trust.

TT-Trustee.

U.S.C .- United States Code.

X-Corporation.

O-Organization.

Y-Corporation.

new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.

Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.

Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.

P-Parent Corporation.

PHC-Personal Holding Company.

PO-Possession of the U.S.
PR-Partner.

PRS-Partnership.

PTE-Prohibited Transaction Exemption.

Pub. L .- Public Law.

REIT-Real Estate Investment Trust.

Rev. Proc .- Revenue Procedure.

Rev. Rul .- Revenue Ruling.

S-Subsidiary.

S.P.R .- Statements of Procedural Rules.

Stat .- Statutes at Large.

T-Target Corporation.

T.C .- Tax Court.

T.D .- Treasury Decision.

CY-County.

D-Decedent.

DC-Dummy Corporation.

DE-Donee.

Del. Order-Delegation Order.

DISC-Domestic International Sales Corporation.

DR-Donor.

E-Estate.

EE-Employee.

plies to both A and B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).

Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.

Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.

Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the

E.O .- Executive Order.

ER-Employer.

ERISA-Employee Retirement Income Security
Act.

EX-Executor.

F-Fiduciary.

FC-Foreign Country.

FICA-Federal Insurance Contributions Act.

FISC-Foreign International Sales Company.

FPH-Foreign Personal Holding Company.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign Corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

IC-Insurance Company.

I.R.B .- Internal Revenue Bulletin.

LE-Lessee.

LP-Limited Partner.

LR-Lessor.

M-Minor.

Nonacq .- Nonacquiescence.

# Numerical Finding List1

Bulletins 2001-1 through 2001-6

## Announcements:

2001-1, 2001-2 I.R.B. 277

2001-2, 2001-2 I.R.B. 277

2001-3, 2001-2 I.R.B. 278
2001-4, 2001-2 I.R.B. 286

2001-5, 2001-2 I.R.B. 286
2001-6, 2001-3 I.R.B. 357
2001-7, 2001-3 I.R.B. 357
2001-8, 2001-3 I.R.B. 357
2001-9, 2001-3 I.R.B. 357
2001-10, 2001-4 I.R.B. 431
2001-11, 2001-4 I.R.B. 432
2001-12, 2001-6 I.R.B. 526

## Revenue Rulings:

2001-2, 2001-2 I.R.B. 255
2001-3, 2001-3 I.R.B. 319
2001-4, 2001-3 I.R.B. 295
2001-5, 2001-5 I.R.B. 451
2001-6, 2001-6 I.R.B. 491

## Treasury Decisions:

8910, 2001-2 I.R.B. 258

8911, 2001-3 I.R.B. 321

8912, 2001-5 I.R.B. 452
8913, 2001-3 I.R.B. 300
8915, 2001-4 I.R.B. 359
8916, 2001-4 I.R.B. 360
8918, 2001-4 I.R.B. 372
8919, 2001-6 I.R.B. 505
8922, 2001-6 I.R.B. 508
8923, 2001-6 I.R.B. 485

8924, 2001-6 I.R.B. 489

8925, 2001-6 I.R.B. 496
8926, 2001-6 I.R.B. 492
8930, 2001-5 I.R.B. 433

## Notices:

2001-1, 2001-2 I.R.B. 261

2001-2, 2001-2 I.R.B. 265

2001-3, 2001-2 I.R.B. 267

2001-4, 2001-2 I.R.B. 267
2001-5, 2001-3 I.R.B. 327
2001-6, 2001-3 I.R.B. 327
2001-7, 2001-4 I.R.B. 374
2001-8, 2001-4 I.R.B. 374
2001-9, 2001-4 I.R.B. 375
2001-10, 2001-5 I.R.B. 459

2001-11, 2001-5 I.R.B. 464
2001-12, 2001-3 I.R.B. 328
2001-13, 2001-6 I.R.B. 514

2001-14, 2001-6 I.R.B. 516

## Proposed Regulations:

REG-251701-96, 2001-4, I.R.B. 396
REG-106542-98, 2001-5, I.R.B. 473
REG-121928-98, 2001-6, I.R.B. 520
REG-104683-00, 2001-4, I.R.B. 407
REG-106702-00, 2001-4, I.R.B. 424
REG-106791-00, 2001-6, I.R.B. 521
REG-107176-00, 2001-4, I.R.B. 428
REG-107566-00, 2001-3, I.R.B. 346
REG-116468-00, 2001-6, I.R.B. 522
REG-119352-00, 2001-6, I.R.B. 525

# Railroad Retirement Quarterly Rates:

2001-2, I.R.B. 258

## Revenue Procedures:

2001-1, 2001-1 I.R.B. 1

2001-2, 2001-1 I.R.B. 79

2001-3, 2001-1 I.R.B. 111

2001-4, 2001-1 I.R.B. 121

2001-5, 2001-1 I.R.B. 164
2001-6, 2001-1 I.R.B. 194
2001-7, 2001-1 I.R.B. 236
2001-8, 2001-1 I.R.B. 239
2001-9, 2001-3 I.R.B. 328
2001-10, 2001-2 I.R.B. 272
2001-11, 2001-2 I.R.B. 275
2001-12, 2001-3 I.R.B. 335
2001-13, 2001-3 I.R.B. 337
2001-14, 2001-3 I.R.B. 343
2001-15, 2001-5 I.R.B. 465
2001-16, 2001-4 I.R.B. 376

1 A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2000-27 through
2000-52 is in Internal Revenue Bulletin 2001-1,
dated January 2, 2001.

## Finding List of Current Actions on Previously Published Items1

Bulletins 2001-1 through 2001-6

Announcement:

98-99
Modified by
Ann. 2001-9, 2001-3 I.R.B. 357
99-79
Superseded by
Ann. 2001-3, 2001-2 I.R.B. 278

2000-97
Corrected by
Ann. 2001-7, 2001-3 I.R.B. 357

Cumulative Bulletin:

1998-2
Corrected by
Ann. 2001-5, 2001-2 I.R.B. 286

Notices:

98-39
Modified by
Notice 2001-9, 2001-4 I.R.B. 375
98-40
Modified by
Notice 2001-9, 2001-4 I.R.B. 375
99-53
Modified and superseded by
Notice 2001-7, 2001-4 I.R.B. 374
2000-21
Superseded by
Notice 2001-1, 2001-2 I.R.B. 261
2000-22
Modified and superseded by
Notice 2001-8, 2001-4 I.R.B. 374
2000-43
Extended by
Notice 2001-13, 2001-6 I.R.B. 514

Proposed Regulations:

REG-116733-98
Withdrawn by
Ann. 2001-11, 2001-4 I.R.B. 432

Revenue Procedures:

83-87
Superseded by
Rev. Proc. 2001-15, 2001-5 I.R.B. 465
92-19
Superseded by
Rev. Proc. 2001-15, 2001-5 I.R.B. 465
96-17
Modified by
Rev. Proc. 2001-9, 2001-3 I.R.B. 328
99-47
Superseded by
Rev. Proc. 2001-16, 2001-4 I.R.B. 376
99-49
Modified and amplified by
Rev. Proc. 2001-10, 2001-2 I.R.B. 272

Revenue Procedures-continued:
2000-1
Superseded by
Rev. Proc. 2001-1, 2001-1 I.R.B. 1
2000-2
Superseded by
Rev. Proc. 2001-2, 2001-1 I.R.B. 79
2000-3
Superseded by
Rev. Proc. 2001-3, 2001-1 I.R.B. 111
2000-4
Superseded by
Rev. Proc. 2001-4, 2001-1 I.R.B. 121
2000-5
Superseded by
Rev. Proc. 2001-5, 2001-1 I.R.B. 164
2000-6
Superseded by
Rev. Proc. 2001-6, 2001-1 I.R.B. 194
2000-7
Superseded by
Rev. Proc. 2001-7, 2001-1 I.R.B. 236
2000-8
Superseded by
Rev. Proc. 2001-8, 2001-1 I.R.B. 239
2000-22
Modified and superseded by
Rev. Proc. 2001-10, 2001-2 I.R.B. 272
2001-13
Clarified by
Notice 2001-12, 2001-3 I.R.B. 328

Revenue Rulings:

64-328
Modified by
Notice 2001-10, 2001-5 I.R.B. 459
66-110
Modified by
Notice 2001-10, 2001-5 I.R.B. 459

Treasury Decisions:

8889

Corrected by
Ann. 2001-14, 2001-2 I.R.B. 286

1 A cumulative list of current actions on previously
published items in Internal Revenue Bulletins
2000-27 through 2000-52 is in Internal Revenue
Bulletin 2001-1, dated January 2, 2001.

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